25 basis points

We’ve already established that predictions are pointless. But they are fun! And I would lose any hope of ever being called a financial pundit if I didn’t have a screaming hot take on the Fed. So, for no reason better than that, some Fed talk.

I think the Federal Reserve should raise rates by 0.25% when they meet this week. That’s not to say they will do it, but they really should.

We’ll get to the why momentarily, but first a bit of background for those who have been on a reality show for the last few months and forced to avoid all current events.

For years, the Federal Reserve kept interest rates at or near zero. Some would say they left them that low for too long because rallies are fun! Some would say the Fed was forced to leave them low for longer than intended because of the pandemic. (I would say there is some truth to both.) But in hindsight, there is now generally a consensus view that wow, the Fed left rates artificially low for a long time.

Inflation began to roar higher early last year. The cause was the low rates. The cause was the post-pandemic spending surge. The cause was Russia’s stupidity in Ukraine. Argue amongst yourselves which of these is true. (Spoiler: They are all true. Look, economics is not simple no matter what politicians try to say.) So, the Fed started raising rates, and raising them fast.

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Since March 2021, the Fed has hiked the Federal Open Market Committee’s target rate by 4.5%. And as recently as a few weeks ago, most had expected another rate hike of perhaps half a percent when the Fed meets again on March 22.

But a lot has changed in the last few weeks. For one, we had the failure of Silicon Valley Bank. The bank failed because it made some stupid decisions. But it also failed because the Fed has rapidly raised rates. (Look, again, there is almost never a simple, one-step answer.) And other banks have run into trouble too. We also have at least some recent data that suggests that even if inflation isn’t yet tamed, it is at least showing signs of cooling a bit.

In just a matter of weeks conventional wisdom has gone from a hike, and perhaps an aggressive one, to narrative about how it is time for the Fed to pause. The market seems to be expecting the Fed to do nothing this week.

If the Fed does pause, they are making a big mistake.

Two big reasons why:

1) A year of talking tough would go up in smoke. The only thing more predictable than rate hikes over the last year is the market commentators screaming “THINK OF THE CHILDREN!” talking about the impact of rate hikes, and predicting the Fed will give up and reverse course at any minute. Those predictions have all proven to be inaccurate, but it has taken the Fed almost a year to gain any semblance of credibility.

Chairman Jerome Powell is very conscious of the perception that he will cave at any moment. He’s increasingly sounding more like John Wayne than a central banker at press conferences.

There’s a credible argument to be made that the lack of belief in the Fed’s fortitude is one of the reasons the Fed has not yet seen the desired impact of rate hikes. While the data on inflation is getting less bad, it is not yet good. If Powell flinches right now, everyone who has (wrongly) predicted the Fed would flinch at any moment for the last year would now get to say, “told you so!” And Fed credibility would take another hit.

It could be dangerous to proceed. But for the big picture, Powell would be better off overshooting and proving his point, and proving the credibility of the Fed, than pulling up short and hope for the best.

2) You don’t yell “fire!” in a crowded theater. Government bodies including the Federal Reserve have gone to great lengths to minimize the fallout from the Silicon Valley Bank disaster and other failures. We’ve talked a lot in recent weeks about how banking is really a confidence game. It isn’t about balance sheets. It is about belief. If depositors and other bank constituents don’t believe that all is well, things tend to spiral downhill in a hurry.

By in large, the response to the crisis has been strong and the message has been received. We can talk about moral hazards and long-term ripples later, but the general impression of the market and the public for now is things have been handled. The last thing we need is some sign from a government institution with inside knowledge suggesting that there is still reason to worry.

Yet, the Fed deviating from the script that it laid out just weeks ago and pausing rate hikes is just that message. Even if the Fed is worried about the banks, even a little worried about the banks, and even if the Fed is worried a rate hike could make things more difficult for the banks, doing the hike and signaling all is well is still the better option than pausing and signaling that there is reason for concern. Confidence games don’t work if the mastermind is short on confidence.

The Fed has shown in recent week it and partners like the FDIC are willing to go to great lengths to clean up a mess. There’s no reason to think they are going to stop intervening now. (Nor should they, but that’s a topic for another time.) If an additional rate hike does cause additional problems, I believe the Fed’s bazooka can solve them.

There’s no easy decision here. Either way, there is the potential for danger. But the Fed’s greatest weapon right now is the perception that things are fully under control, and fighting the Fed is pointless.

The best path from here is to raise rates, risk lighting small fires that will have to be dealt with, and in doing so present the message that the Fed is no longer worried about an inferno.

The economy can weather a rate hike a lot better than it can handle the perception that the Fed is freaking out. Confidence matters.

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