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Fed Chair Powell in ‘a terrible position’ ahead of FOMC meeting, economist says

Dreyfus and Mellon Chief Economist Vincent Reinhart joins Yahoo Finance Live to discuss the expectations for the Fed ahead of Wednesday’s FOMC meeting, the U.S. banking system, market volatility, the state of the economy, and the outlook for the U.S. debt ceiling.

Video Transcript

- Well, as Jen said, for the Fed, the hardest part comes after that expected hike today. The Fed largely expected to raise rates this afternoon, but the central bank must now walk a tightrope, signaling rates will stay higher for longer to fight inflation even as markets still anticipate some form of a pivot. Joining us with more, Vincent Reinhart, chief economist at Dreyfus and Mellon. Vincent, how does Jay Powell manage that messaging today?

VINCENT REINHART: With a lot of difficulty. The Fed Chair is in a terrible position. Basically since October, market participants really haven't believed their guidance that they would raise rates, keep them at a plateau through all of 2023. They've been pretty consistent with that message. But there's been a pivot priced in really for nine months.

So basically, the Fed chair has to deliver a dovish message. They're no longer assuming the next policy action will come in June and it'll be a tightening. They have to be better balanced. But he has to signal that they're leaning forward, that this is not necessarily a stop. They may be willing to-- they would be willing to tighten again if the data drive them to it.

- I mean, given the recent economic data, I mean, it feels like there's a bit of a mixed picture here. On the one hand, we saw some of the JOLTS numbers coming down just a bit. And yet you look at private payrolls, how they surged in April. When you consider where that is right now, should there be a pause on the other end of this meeting?

VINCENT REINHART: So I think the committee should be balanced as to their view on the next action. I.e., they could see if the data drive them to it, the case for additional policy action. The hurdle for easing is enormous. But they should just say they're data-dependent. Does it mean they will act in June or not? They'll have to see strong growth in employment, stubborn pressures in service inflation, and the unemployment rate putting pressures on labor markets. If they get that trifecta, they could tighten again. But chances are this is the end of the line.

- Vincent, how do you think the regional bank failures that we've seen makes its way into the Fed's calculation? As we heard from a number of our guests over at the Milken Conference, there's the big banks who said, look, this is kind of the end of it. There is no impending crisis, a contagion effect. And yet you've got others who say this is really just the beginning that's going to put us deeper into recession.

VINCENT REINHART: So every time the Fed tightens monetary policy, there's a constriction in the price and availability of credit. Sometimes it's ugly. The regional bank problems are a case of it being ugly. The Fed had to expect restraint in credit when it raised the funds rate 4 and 3/4 percentage points in just over a year. By two o'clock, it'll be five percentage points. They don't necessarily get it in a nice straightforward and orderly process.

From the vantage point of monetary policy, I think Chair Powell is going to invoke a separation principle, that regulators and supervisors have dealt with the problem, invoking a systemic risk exception to keep depositors safe, offering a new term lending program to increase the liquidity of institutions. And because they've done their job right, he's got a free hand on monetary policy. And he'll use that free hand to firm one more time.

- How does the political risk make its way into this thinking for the Fed? We've obviously got this debate that's going on over the debt ceiling. We've heard Treasury Secretary Janet Yellen saying we could-- the US could default on its debt as early as June 1st. What do you think Jay Powell is likely to say about it? What do you think he should say?

VINCENT REINHART: OK, so politics involve both what are they going to do about the debt ceiling and then, over the medium term, are they going to get pressured as the unemployment rate rises and the higher rates begin to really bite into federal finances by raising interest costs. So let's set aside that medium-term risk. Chair Powell is going to be getting asked about the debt ceiling.

My most confident prediction, beyond that they'll raise the funds rate a quarter point, is his answer will be I'm going to stay in my lane. It is what it is. We fully expect the political class to do the right thing because it would be unthinkable to default. We stand willing to do whatever it takes operationally to help the Treasury along. He's not going to get past that.

He's going to say I don't deal with hypotheticals, I don't want to talk about default because it is inconceivable. And behind the scenes, they've put in place the procedures, first to prioritize Treasury payments if Secretary Yellen tells him to do so. And they will think about what they do if markets got strained if it actually did happen.

- OK. We know the Fed likes to always shy away from weighing in on any side of politics. Vincent Reinhart, chief economist at Dreyfus and Mellon, appreciate your time today.

VINCENT REINHART: Thank you.

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