Markets Weigh on Weaker-Than-Expected US Data

Yesterday, the Fed’s Loretta J. Mester – president and CEO of the Federal Reserve Bank of Cleveland – said that the monetary conditions will need to stay tight in order to cool inflation and that rates may need to stay above 5% for an extended period of time. Mester said that she sees inflation at around 3.75% by the year’s end and 2% by 2025 with growth in the US being marginal this year. Mester said that she sees the Fed’s monetary policy “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.”

Mester also discussed the banking sector’s resilience in the wake of SVB’s collapse and the fragility with Credit Suisse. Here, she said that they are closely monitoring the banking sector in light of the stresses that rate hikes are causing on some bank’s balance sheet.

Given the correlation between the effects that rising interest rates have had on banks’ balance sheets and recent bank failures, central banks were brought face-to-face with a fragile trade-off. Namely, opting for further monetary tightening to combat inflation on the one hand while not wanting to put further stress on banks’ balance sheets on the other. Indeed, as The Economist notes “at the end of 2022 there were $620bn of unrealised securities losses on banks’ books”, though with inflation continuing to cause persistent headaches for central banks, policy makers still opted to raise rates across the board, though in a softer manor.

While Mester does not have a vote on the Federal Open Market Committee, her remarks are indicative of those on the more hawkish side.