Editorial. US Fed’s mixed signals

After repeatedly stating its resolve to wrestle down US inflation to 2 per cent, it would have been extraordinary indeed for the Federal Reserve to take its foot off the pedal on rate hikes in its latest meeting. The US reported a Consumer Price Index (CPI) inflation reading of 6 per cent in February (5.4 per cent in January), while the supply of jobs outpaced demand. Therefore, the Fed perhaps had little choice but to look through the recent turmoil in smaller US banks while raising policy rate by a further 25 basis points, taking its target rate to 4.75- 5 per cent.

The Federal Open Market Committee’s (FOMC) statement, and Chairman Powell’s address later, contained obligatory statements about the need to get CPI inflation down to 2 per cent. But for the first time since this tightening cycle began, official releases also carried distinctly dovish overtones. The FOMC watered down its hawkish language to say that “some additional policy firming” would be appropriate to quell inflation. Powell admitted that FOMC members debated a pause before voting for a 25-basis point rate hike. He also noted that recent events at US banks were leading to tighter credit conditions, which could slow the economy and jobs growth.

More than the rate action though, it was the Fed chair’s view on contagion risks to US banks from the SVB (Silicon Valley Bank) collapse that was eagerly awaited. On this score, his statements were vague. Asked specifically whether the SVB collapse was a result of failure of regulatory supervision, Powell pinned the crisis wholly on risk management practices at SVB, terming the bank an ‘outlier’ and reiterating that the US banking system was ‘sound and resilient, with strong capital and liquidity’. Quizzed on whether the rate hike would aggravate the crisis, he suggested that problems at ‘small US banks’ would be addressed by the Fed’s special window, which allows them to borrow against treasury holdings without haircuts. But the opening of this liquidity window, with $300 billion at the disposal of US banks, has also been sending out confusing signals to markets on interest rates. With the accommodative liquidity stance working at cross-purposes to its rate hikes, US treasury yields have declined from over 5.2 per cent to 4.5 per cent in recent weeks.

Economic projections put out by FOMC members paint a sombre picture. US GDP growth forecasts have been trimmed to 0.4 per cent in 2023 and 1.2 per cent in 2024, from 0.5 per cent and 1.6 per cent forecast last December. Unemployment is expected at 4.5 per cent and 4.6 per cent for the two years, while inflation is expected to ease to 2.1 per cent only by 2025. The sluggish growth trends expected in the US economy, taken with the recent turmoil in its BFSI sector, suggest that India will find it tough to avoid spill-over effects on its growth in the months ahead. With the decline in US market interest rates taking some of the pressure off it to follow in the Fed’s footsteps, the Monetary Policy Committee will have leeway in its upcoming meeting to consider a pause in rates and give domestic growth impulses a chance.    

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