(News Bulletin 247) – The American Federal Reserve, which meets on Tuesday and Wednesday, finds itself torn between, on the one hand, the imperative to stabilize a banking sector in difficulty and, on the other hand, the need to continue its interest rate hikes to curb persistent inflation.

Between price stability and that of the financial system, which should be chosen? Both, answers Christine Lagarde. “I think there is no trade-off [un arbitrage, un choix, NDLR]“between these two subjects, declared the President of the European Central Bank (ECB) last Thursday, during her press conference.

The President of the Federal Reserve (Fed), Jerome Powell, will perhaps not have the same words, while his institution meets from Tuesday to Wednesday evening to take, in particular, a decision on its key rates.

“The ECB is not at all in the same situation as the Fed, no European bank is on the verge of bankruptcy and the controls are not the same. It is not possible to draw a parallel”, underlines Philippe Waechter, director of economic research at Ostrum Asset Management.

Emergency cash

The recent banking crisis, which led to the failure of Silicon Valley Bank, Signature Bank and injections of deposits from eleven major banks into First Republic, has greatly complicated the Fed’s equation.

Until Friday, March 10, “the Fed had a big complex problem to solve. Now it has two. And maybe even three”, summarizes Oddo BHF.

Created in 1913 following a bank panic in 1907, the Federal Reserve must in essence maintain the stability of the financial system. This is also why it set up a new credit facility on March 12, called the Bank Term Funding Program (BTFP).

“This new facility can provide banks with loans for up to one year against Treasury, Agency and RMBS securities. [Residential mortgage backed securities, des produits financiers adossés à des créances immobilières] which are valued at par, thus preventing institutions in difficulty from having to liquidate them in poor market conditions”, notes Oddo BHF.

Faced with the determination of the Federal Reserve, the banks did not hesitate to activate lines to find new money. According to Capital Economics, the “discount window” or the Fed’s marginal lending facility soared last week, being mobilized to the tune of 153 billion dollars, a level higher than the maximum of the financial crisis of 2008. we are only talking about one instrument.

Xavier Chapard of La Banque Postale Asset Management notes that the Fed’s emergency lending operations have “lead to a $440 billion rebound in banks’ reserves at the Fed, reversing a year of their related decline in one week. Quantitative Tightening [resserrement monétaire, NDLR]”.

Stop or even on key rate hikes?

De facto, the Federal Reserve’s balance sheet is growing as the central bank has until now had to cut liquidity to combat persistent inflation in the world’s largest economy. In other words, the Fed finds itself in a situation where it must put out two fires by taking measures which, in one case, risk reigniting one of the two fires.

“The dilemma for the Fed is that, absent the turbulence in the banking sector, economic data released this week could have strengthened the case for a 50 basis point (0.5%) rate hike. “, emphasizes Capital Economics.

“The Fed is in a difficult situation as its meeting approaches (…) If it continues to raise rates, it strengthens its anti-inflationary credibility but risks increasing financial tensions. because experience teaches us that a serious malfunction of our banking system is in a way above any other risk”, explains Xavier Chapard of La Banque Postale Asset Management.

“If it does not raise its rates, it can limit the pressure on the financial markets but could risk unanchoring inflation expectations and could even reinforce fears about the banks (the situation of the banks which it is monitoring closely is worse than ‘we don’t think so?)”, he continues. The economist expects a rate hike Wednesday night limited to 25 basis points, or 0.25 percentage points.

“A question of hierarchy in priorities”

“If the Fed and other regulators fail to keep the situation under control, there is a risk of a financial crisis, ultimately leading to a deflationary shock and a recession. That is not the way it is. desirable to lower inflation. On the other hand, if they do too much and inject too much liquidity, they can fuel overheating”, agrees Oddo BHF who considers that a 25 basis point increase can be “a good compromise”.

An opinion that does not share Philippe Waechter, who thinks that the Federal Reserve will refrain from raising its rates.

“It’s a question of hierarchy in priorities. The Fed must deal with the most urgent and in this context, the inflation objective goes into the background”, compared to financial stability. “there should be no dilemma”, he insists.