SBNY - Cleveland Fed's Mester still sees policy rate over 5% but keeps eye on lending

2023-04-20 12:20:54 ET

While Cleveland Fed President Loretta Mester still expects the Federal Open Market Committee to push the federal funds rate target range to over 5%, the central bank will have to keep a close eye on how much banks pull back on lending due to the recent stresses in the financial system.

Market participants agree with the forecast of higher rates. The probability of a 25-basis-point rate increase at the FOMC's May 2-3 meeting stands at 82.8%, up from a 67.0% probability a week ago, according to the CME FedWatch tool .

Even before the failure of three banks in March — Silvergate ( SI ), Silicon Valley Bank ( OTC:SIVBQ ), and Signature Bank ( OTC:SBNY )  — banks had started to tighten their credit standards, making credit less available, Mester said Thursday, according to prepared speech at the Akron Roundtable. That could lead to even tighter credit standards, resulting in slower spending by households and businesses and a pullback in hiring, she said.

"This would work in the same direction as tighter monetary policy," Mester said. "So we will need to continue to assess the magnitude and duration of these effects on credit conditions to help us calibrate the appropriate path of monetary policy going forward. This is the prudent thing to do."

In the past year, the Fed has ratcheted up its policy rate to 4.75%-5.00% from near zero before its March 16, 2022 meeting. "Yet demand is still outpacing supply in both product and labor markets and inflation remains too high," Mester said. "In order to put inflation on a sustained downward trajectory to 2%, I anticipate that monetary policy will need to move somewhat further into restrictive territory this year, with the fed funds rate moving above 5% and the real fed funds rate staying in positive territory for some time."

She expects employment growth will continue to slow, and conversely, the unemployment rate will rise to ~4.5%-4.75% by the end of 2023. Inflation, meanwhile, should improve to ~3.75% this year and reach the Fed's goal of 2% in 2025, she added.

Mester's rate expectations agree with recent comments from St. Louis Fed President James Bullard, who contends that higher rates are needed as inflation remains hot. Last week, Federal Reserve Governor Christopher Waller also saw the need for further monetary tightening.

Friday is the last day that Fed officials will be able to discuss their outlooks on monetary policy, as the blackout period before the May meeting begins on Saturday, April 22.

Developing... check back for updates.

According to the minutes from the Fed's March meeting, several FOMC participants had considered keeping rates unchanged to asess the effects of the stresses that had emerged in the banking sector.

More on the Fed:

The Bulls Are Trapped With Nowhere Left to Run, says Mott Capital Management

More Trouble Lies Ahead, says SA contributor Mark J. Grant

Fed can potentially end policy tightening after one more 25-bp hike: Bostic

BofA: Fed is in a 'wait and see' mode on future rate decisions

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