Wednesday, May 3, 2023

The Fed Fighting Wrong Battle

 Financial FAQs

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CalculatedRisk

First Republic Bank’s takeover by the FDIC highlighted just how vulnerable our banking system is to higher interest rates. It had more than 80 percent uninsured deposits, just like the other failed banks vulnerable to higher interest rates that reduced the value of their assets.

So even though higher interest rates have been causing most harm to the banking system, causing panicky depositors to withdraw their funds, the Fed Governors don’t seem ready to quit raising interest rates. We will know more tomorrow at the end of their two-day FOMC meeting.

The Fed is focusing instead on the job market, believing rising wages are the main inflation culprit, and higher interest rates will slow employers’ demand for more workers.

That is already happening, as the Labor Department’s Job Opening and Labor Turnover Survey (JOLTS) March report showed a softening labor market.

The JOLTS report said layoffs jumped by 248,000 to 1.8 million, the highest level since December 2020. The increase was led by the construction industry, which shed 112,000 positions. The decline likely reflected the job losses in the housing market, which has been hammered by higher mortgage rates.

Accommodation and food services lost 63,000 jobs, while the health care and social assistance category reported 42,000 layoffs. Employment in the leisure and hospitality sector remains below its pre-pandemic levels.

And wage increases are also lessening as economic growth has slowed to 1.1 percent in the first quarter 2023 from 2.6 percent growth in last quarter of 2022.

Yet the real inflation culprit is lack of adequate goods and services that has been unable to meet such a soaring demand for more supplies, exacerbated by higher borrowing costs. Factory orders, for instance, have already weakened. U.S. manufactured goods rose just 0.9 percent in March, the Commerce Department said Tuesday. The increase followed two months of decline.

The Fed isn’t helping matters by wanting to raise interest rates enough to boost unemployment from the current 3.5 percent to 4 to 5 percent. Fewer working employees also reduces said supply.

Which brings us to other reasons supply chains aren’t producing more—higher energy prices and higher tariffs that raise import costs, and a rising tide of economic nationalism that encourages more to be ‘Made in USA’ and less foreign trade that also disrupts supply-chains.

Nobel Prize-winner Joseph Stiglitz has been most vocal on the harm continuing rate increases are causing in a recent Project-Syndicate article.

“The Fed, like other independent central banks, jealously guards its credibility. The risk of losing it has been cited as the reason for the Fed’s interest-rate hikes of the past year, which went far beyond normalizing the ultra-low rates that characterized the post-2008 era. But by failing to recognize the risks posed by its rapid rate increases, and how more than a decade of near-zero interest rates had exacerbated these risks, the Fed undermined its own credibility – precisely the outcome it sought to avoid.”

I said last week Treasury Secretary Janet Yellen in a recent Fareed Zakariah interview on CNN thought an economic soft landing was possible, despite warnings that the recent bank failures could cause banks to tighten in their lending criteria, contributing to a slowing economy.

It is now obvious that higher interest rates are harming the banking system. Leading economists are also worrying. Will Chairman Powell and the Fed Governors listen?

Harlan Green © 2022

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

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