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Jerome Powell has an obvious problem with no easy solution: Morning Brief

This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Wednesday, March 22, 2023

Today's newsletter is by Myles Udland, Head of News at Yahoo Finance. Follow him on Twitter @MylesUdland and on LinkedIn. Read this and more market news on the go with the Yahoo Finance App.

The Federal Reserve has a tall task on Wednesday.

The central bank must convince investors it is serious about two obvious problems, each of which suggests an equal and opposite solution.

On the one hand, the Fed is facing inflation that remains, to use their own words, "too high." Consumer prices rose 6% over the prior year in February which, while marking the slowest annual increase since Sept. 2021, is still three times higher than the Fed's 2% target.

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For central bankers, higher inflation has a clear response: raise interest rates. And investors expect this process to continue on Wednesday, with investors pricing in an 85% chance the Fed raises rates by 0.25%, according to data from the CME Group.

On the other hand, the Fed is facing a banking crisis that is, in part, traceable back to its own actions to choke off inflation. Since the beginning of March, three U.S. banks have failed and others — most notably California-based First Republic (FRC) — are teetering on the edge amid deposit outflows.

All else equal, in a banking crisis investors would expect the Fed to cut rates to ease pressure on the financial system.

As one strategist told Yahoo Finance's Jennifer Schonberger earlier this week, this conundrum finds the Fed "between a rock and a hard place."

Which likely understates the magnitude of the central bank's problem, a problem which calls for clear and obvious answers that are clear and obvious opposites.

UNITED STATES - MARCH 7: Federal Reserve Chairman Jerome Powell testifies during the Senate Banking, Housing, and Urban Affairs Committee hearing titled The Semiannual Monetary Policy Report to the Congress, in Hart Building on Tuesday, March 7, 2023. (Tom Williams/CQ-Roll Call, Inc via Getty Images)
Federal Reserve Chairman Jerome Powell testifies during the Senate Banking, Housing, and Urban Affairs Committee hearing titled The Semiannual Monetary Policy Report to the Congress, in Hart Building on Tuesday, March 7, 2023. (Tom Williams/CQ-Roll Call, Inc via Getty Images) (Tom Williams via Getty Images)

Now, interest rates are only one tool available to the Fed at any point in time.

More amorphous concepts like "forward guidance" or more esoteric — though concrete — solutions like swap lines and term funding programs are available to the Fed.

The latter have been stood up in recent weeks to ease strain on the financial system. The former will feature during Powell's press conference on Wednesday afternoon.

"The Fed faces a tough decision this week and an even more challenging communication challenge because of the stress in the banking system," wrote Ryan Sweet, chief U.S. economist at Oxford Economics, in a note to clients this week.

"The Fed will likely stress that another hike is needed to cool the economy and tame inflation, which remains well above their target, but also highlight the actions taken and tools available to them to help alleviate the stress in the banking system."

The problem with this setup for the Fed, of course, is that when leaders in a crisis say the answer is "both" what most people hear is "neither."

Since 1977, the Federal Reserve has worked to fulfill a "dual mandate" of achieving maximum employment and stable prices.

As an organization, we could say the Fed has indeed been in service to two leaders. Critics will note this sits at the heart of the Fed's shortcoming.

But as Yahoo Finance's Julie Hyman wrote Tuesday morning, the Fed must now also consider its so-called "third mandate" of maintaining financial stability.

As The Office once asked its audience: What great organization doesn't have two leaders?

And so we may, then, ask Jay Powell — and what about three?

What to Watch Today

Economy

  • MBA Mortgage Applications; Federal Reserve monetary policy decision

Earnings

  • Ollie's Bargain Outlet (OLLI), Chewy (CHWY), Petco (WOOF), Winnebago (WGO), Steelcase (SCS), Worthington Industries (WOR), KB Home (KBH)

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