Fed’s Bullard wants to press ahead with higher interest rates, thinks financial stress will abate

Bullard said this was based on his view that there was an 80% chance that the stress in the banking sector will abate. He added that if stress intensified, he would change his preferred rate path.

The U.S. economy will be cushioned somewhat from the fallout of the recent stress in the banking sector because long-term bond yields have fallen, he said.

Bullard is one of the more hawkish regional Fed bank presidents. He is not a voting member of the Fed’s interest-rate committee this year. Taken as a whole, Fed officials penciled in an endpoint of 5.125% for the benchmark rate.

Earlier this week, the Fed raised its benchmark rate by 25 basis points to a range of 4.75%-5%. Bullard is calling for three more quarter-point hikes to a range of 5.5%-5.75%.

Silicon Valley Bank was a “quirky bank” with its own special problems and regulators can handle the fallout from it, the St. Louis Fed president said.

Still, the government stands ready to take additional actions as needed, he stressed.

The rapid collapse of the bank caught everyone by surprise, even executives at SVB, so it is natural that it has created concern in markets and caused investors to reassess.

Banks in his district have angst but not actual problems, Bullard said.

The Fed’s new lending facility set up two weeks ago “goes to the heart of the matter” and should work, he said. That program gives banks loans at special rates so they won’t have to rapidly sell assets if hit by any run on their deposits.

Stepping back, it is “relatively common” that some banks don’t adapt to changing interest-rate environments despite clear signals from the Fed, Bullard said.

He listed the collapse of Continental Illinois bank in 1984, the Mexican “Tequila Crisis” in 1994, the bankruptcy of Orange County in 1994, and the collapse of Long-Term Capital Management in 1998.

“These events received considerable attention at the time, but were not ultimately harbingers of poor U.S. economic performance,” Bullard said.

While financial stress “can be harrowing,” it also tends to reduce the level of interest rates and that tends to be a bullish factor for the economy.

During the current banking sector stress, the 10-year Treasury yield has declined by 50 basis points and the 2-year Treasury yield has declined by about 100 basis points.

Yields have fallen again on Friday.

This natural reaction in markets is a “silver lining,” Bullard said.

Overall, regulators find themselves in much better shape to respond to bank stress as a result of the Dodd Frank law put in place after the 2008 financial crisis, he said.

Then, Fed officials were creating programs “on the fly,” Bullard said.

Financial stress is higher now but nowhere near 2008-2009 levels, he noted.

See: Emergency borrowing from Fed dips, a sign that bank stress may be easing

On the other hand, “appropriate monetary policy can continue to put downward pressure on inflation,” Bullard said.

The St. Louis Fed president noted that the economy has been stronger than expected in the first quarter and the labor market has seen unprecedented strength that should continue to support consumer spending.

While inflation is too high, it has declined recently, Bullard said. He defended the Fed’s rapid increase in its benchmark interest rate over the past year, saying this has dampened the public’s expectations of inflation.

“This bodes well for the disinflationary process in 2023,” he said.

U.S. stocks
DJIA,
+1.26%

SPX,
+1.44%
were lower in late morning trade on Friday on continued worries about the banking sector. The yield on the 10-year Treasury note
TMUBMUSD10Y,
3.471%
slipped to 3.36%, well below the 4% level seen before the collapse of Silicon Valley Bank.