The Fed should keep raising rates as overblown credit fears make a recession unlikely, Fed President Bullard says

• The Fed can keep raising rates as there's little risk of recession caused by recent bank stress, Fed president James Bullard said.
• The lending facilities extended to banks have been working, offsetting a bigger credit crunch.
• The recent drop in bond yields will also help mitigate economic challenges, he said.

Fears of a credit crunch are likely exaggerated, and the Federal Reserve shouldn't shy away from further interest hikes to fight inflation, St. Louis Fed President James Bullard said on Thursday.

Instead, the central bank should remain focused on bringing inflation back towards 2%, he said in a speech given to the Arkansas Bankers Association in Little Rock, Arkansas.

"Financial stress seems to be abated, at least for now," Bullard later told reporters. "And so it's a good moment to continue to fight inflation and try to get on that disinflationary path."

In March, the Fed lifted the interest rate by another quarter point to a 4.75%-5% range, but  indicated a possible willingness to slow down further tightening in response to turmoil in moving through the banking sector. 

But Bullard in his remarks cited an 85% probability that banking stresses will keep easing, and said that the conditions are not strong enough to draw the US into a recession — especially as recent lending facilities extended to banks have been proven effective. 

"It's not clear to me that there will be much of a pullback on lending by these types of banks," Bullard said. "As long as they have enough liquidity and enough capital they will just as likely go ahead and make those loans."

Bullard had previously forecast a Fed rate of 5.50%-5.75%, and has been a proponent of the bank's aggressive policy in order to tame high prices. Citing a strong labor market, he cautioned on Thursday that inflation would only get stickier if ignored.

In his view, the sharp plummet in bond yields should also help ease challenges brought on by the banking sector. In past weeks, the 10-year US Treasury has fallen 50 basis points, while 2-year note fell by 100 basis points.

"This may help to mitigate some of the negative macroeconomic fallout that might otherwise occur in the aftermath of a period of financial stress," he said.

A number of top economists recent have come out against interest rate cuts, such as Mohamed El-Erian, who forecast an inflationary crisis if the Fed was to ease its policy.

And rate cuts may not be the most effective answer to current credit anxieties, Bank of America explained in a note published Thursday. Analysts said that even though lower interest may bring some relief to at-risk commercial estate debt, the market would still be exposed to cyclical challenges brought on by a hard landing the a rate cut would be in response to.

Currently, CME data shows that investors are evenly split on whether the Fed will raise or hold rate steady at its upcoming meeting on May 2-3.