Financial conditions have eased enough to get the Fed to hike in March

For years, many Fed watchers have claimed that the Federal Reserve has a secret third mandate beyond inflation and full employment. And this past February 21st, for the first time a Fed President said directly that, indeed, the Fed does have a third mandate: financial stability.

Neel Kashkari, the Minneapolis Fed President made the remarks in a Speech and Q&A session captured on and posted on YouTube. One might say, ‘of course the Fed has a mandate to maintain financial stability. Every central bank in the world sees that as a core function.’ And indeed, this was the tenor of Kashkari’s remarks. In fact, just four days earlier, the Fed official told CNBC about the stability of US banks that “the banks are stronger. They have more capital, deeper sources of liquidity. Progress has been made, but if we have a stressed economic environment and multiple banks are in trouble at the same time, the government is going to have to step in and bail them out.” 

Why this matters: The first and most obvious reason the financial stability mandate matters is because it has led to higher capital requirements for big banks and a stricter regulatory environment. The banks are pushing back against those requirements. And Donald Trump plans to give them regulatory relief. Trump is also scheduled to nominate a bevy of officials to the Fed’s board, remaking the institution in the process – and perhaps its approach to regulation and bank capital requirements.

But the Fed’s financial stability mandate also affects interest rates. Economists at Goldman Sachs say that financial conditions have eased so much that the Fed is ready to hike in March. They see financial conditions having eased 45 basis points since the Dec hike, with stocks up, long term yields down, and spreads between 2- and 10-year bonds tighter. Put simply, after a period in which the Dow Jones Industrial Average made 12 consecutive all-time highs, the Fed believes it should move to offset easier financial conditions with an interest rate hike sooner rather than later. And now markets put the odds of a March hike at 90%.

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