The Fed faces a ‘no-win situation’ but must keep raising interest rates anyway, says former Fed official
By Matt Egan
The shocking implosion of Silicon Valley Bank should not deter the Federal Reserve from its war on inflation, according to former FDIC and Fed official Thomas Hoenig.
“The Federal Reserve is in the hot seat. It’s a no-win situation for them,” Hoenig, the former vice chair of the Federal Deposit Insurance Corporation, told CNN in a phone interview on Monday.
Raising interest rates at the Fed’s monetary policy meeting next week could add to the financial pressure facing the banking system, in part by further depressing the value of the bonds that banks are sitting on.
But Hoenig, who led the Kansas City Fed during the 2008 financial crisis, urged the Fed to keep hiking rates because inflation hasn’t gone away.
“It says to the world inflation is still the problem,” said Hoenig, who is now a distinguished senior fellow at the Mercatus Center at George Mason University in Virginia. “Get inflation down. Then you can have a long period of stability, hopefully. If you don’t get inflation down, you get a long period of instability.”
Despite high inflation, many investors are betting there is a growing chance the Fed holds steady at next week’s meeting. That marks a significant shift from just a week ago when the markets were pricing in a half-point rate hike.
“In light of the stress in the banking system,” the Fed is likely to keep rates unchanged next week, Goldman Sachs told clients on Sunday.
Nomura is going a step further, predicting the Fed will completely reverse course and start cutting interest rates next week and halt the shrinkage of its balance sheet.
“This could somewhat reduce the risk of further bank runs, as well as reduce unrealized capital losses,” Nomura told clients in a note on Monday.
This marks a dramatic reversal, given that Nomura previously expected a half-point rate hike.
Hoenig said he would be “disappointed” if the Fed started to cut interest rates now, warning of “long-run consequences” that could invite a repeat of 1970s-style runaway inflation.
Seeking to ease the banking crisis, the federal government announced Sunday that all depositors at Silicon Valley Bank will be made whole, even those above the $250,000 FDIC insurance limit.
Hoenig said he doesn’t know if the federal response will be enough to restore stability, but said the public will now expect similar treatment if other banks get into trouble.
“If a bank fails, the expectation is the FDIC would help uninsured depositors,” he said. “And that’s not for sure.”
Asked if the response amounts to a bailout, Hoenig said it’s true that stock and bondholders are not getting rescued but noted that wealthy depositors are.
Hoenig also pointed to the new Fed lending program will let banks swap out bonds they are holding at full value, allowing them to avoid paper losses they are currently staring at.
“That’s a helluva favor,” Hoenig said.
The-CNN-Wire
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