Jerome Powell is in 'a position that none of us want to be in,' financial expert says

Christopher Leonard, Executive Director, Watchdog Writers Group at the University of Missouri School of Journalism, joins Yahoo Finance to discuss Federal Reserve Chair Jerome Powell, the bank crisis, and the Fed's response to inflation.

Video Transcript

DAVE BRIGGS: It was, indeed, a busy week for Fed Chair Jerome Powell as the central bank made a move to hike rates by another 25 basis points on Wednesday, the Fed Chair giving some guidance on where things can go from here. Let's listen.

- It's possible that this will turn out to have very modest effects. These events will turn out to be very, very modest effects on the economy, in which case inflation will continue to be strong, in which case, the path will look-- might look different. It's also possible that this potential tightening will contribute significant tightening in credit conditions over time. And in principle, if that means that monetary policy may have less work to do, we simply don't know.

DAVE BRIGGS: Is this recent chaos a boon in the battle against inflation? And what will happen to the economy as Powell continues his fight? To discuss where we go from here, let's bring in executive director of the Watchdog Writers Group at the University of Missouri School of Journalism, Christopher Leonard. Christopher, good to see you, sir. So given the banking crisis, given the ongoing hot inflation in the tight labor market, how do you feel Jerome Powell did this week?

CHRISTOPHER LEONARD: Well, I mean, as you pointed out earlier, Jerome Powell is in a position that none of us would want to be in. He has an unenviable job. The Fed is in a tight position. And last year, I don't think it's fair to say that they raised interest rates. What happened last year was an interest rate shock, going from 1% to 5%. And that is really the root cause of this volatility in the banking sector that we're seeing right now. And Jay Powell knows that really well. He's been talking about this for years inside the Federal Reserve about the sort of shock effect that you can have from interest rates, like interest rate hikes like this, after a decade of ultra low interest rates coupled with quantitative easing.

So the position he's in is trying not to essentially make the bank sector implode while fighting inflation. And I think we're in a state of real risk because what Jay Powell is telegraphing, what the entire FOMC is telegraphing, is that we are going to see rates at or around 5% for the rest of 2023. And that is going to have significant, significant knock-on effects in financial markets. And, you know, obviously, to state the obvious, the real question here is where does inflation go. The Fed said yesterday they're seeing an elevated risk of inflation. That's not great language. They're going to have to keep rates high to get down to that target of 2%.

SEANA SMITH: How much more aggressive then, Chris, do you think the Fed might potentially get if they're still looking for that 2% inflation number?

CHRISTOPHER LEONARD: Not much more aggressive than where they are right now. You know, it seems like they're expecting rates to sort of flatten out from here at 5%. But again, in terms of the whole vibe check, I'm sorry to say I'm on the ugly side. I'm in the red right now because we haven't seen 5% interest rates since 2007, since before the global financial crisis. This is a major change. And the key is not whether or not the Fed is going to hike rates further. I don't think that there's much chance of that.

But the big question is what is the world going to look like throughout this year, if a 5% interest rate is maintained? That's the question. Are they going to keep the rate at 5 throughout 2023? The signal that they're sending is that yes, they are. But we're already seeing a lot of volatility at a 5% rate. And so the question is, what happens going forward from here?

DAVE BRIGGS: Of course, the markets are betting that Powell is wrong and that they will begin to cut this year. If the markets are wrong and if Powell is right, what will the economy look like later this year?

CHRISTOPHER LEONARD: I love that you're bringing that up. It is the most bizarre situation. I don't think Jay Powell could be more clear. He had that big statement in August, in Jackson Hole, where he said there's going to be pain. We're going to fight inflation. He invoked the name of Paul Volcker, you know, the legendary Fed chairman who fought inflation in the '80s, causing a massive recession. And then you've got Wall Street saying, yeah, we don't think so. We think you're going to be cutting rates by this summer. We think you're going to step off the gas pedal in terms of rate hikes when you see the damage that gets done. So this is a conflict, if you will.

I think we need to take the Federal Reserve seriously when Jay Powell says and the so-called plot or the estimates that the FOMC have shows they're going to stay at 5 throughout 2023. And for the economy, the effects are going to be serious. I mean, I'm not an alarmist by nature. But you know, I've been pretty skeptical in my book about the Fed, "The Lords of Easy Money," looking at the super easy money policies over the last decade. It is hard to envision a world where we stay at 5% for the rest of 2023 without having massive downward adjustments in asset markets.

SEANA SMITH: So, Chris, what more, then, does that look like? When you talk about a recession, it sounds like you think that's a sure thing. How deep of a recession could we potentially be looking at?

CHRISTOPHER LEONARD: I mean, great question. So when rates are this high, you see destabilization and drops in markets from corporate bonds to stocks. OK, we're seeing all of that. Having a bank like Silicon Valley Bank go under virtually overnight because of an effect that is directly tied to the rate hikes-- that's what wiped out the value of Silicon Valley's Treasury bonds, and incidentally, the entire banking industry. When you look across it, there's about $600 billion in unrealized losses on the bonds, on their balance sheets, but those losses get realized if the banks have to sell the bonds. This is why we're seeing this increased anxiety around the value of banks.

What I'm getting at here is we don't know. We don't know how deep that recession might be because whatever the old Warren Buffett statement about the tide going out is when you see who hasn't been wearing a swimsuit, we're discovering that now. And I just can't overstate March isn't even over. We're the first quarter into a year of having these elevated high rates, and the severity of the recession or the downturn will depend on how severe the banking crises are. And the crises and the sort of credit risk and this other stuff like corporate junk debt, massive market, highly sensitive to higher rates, as these companies are trying to roll over their bonds in a much higher interest rate environment. These things are going to become more and more apparent the longer rates are elevated.

DAVE BRIGGS: Man, this is a continuing conversation we would really love to continue. Unfortunately, we are out of time. Christopher Leonard from the terrific school of journalism at Missou, good to see you, sir. Come back and see us.