One year into its inflation fight, the Fed faces a murky future

The Federal Reserve began its war on inflation exactly one year ago, launching its most aggressive interest rate hike since the 1980s in a bid to cool the economy.

Since March 16, 2022, the US central bank has raised the federal funds rate eight times, highlighting how seriously politicians are taking to fight the inflationary crisis. As a result of the increase, the main base federal funds rate is in the range of 4.75% to 5%, the highest rate before the 2008 financial crisis.

The ninth increase is just around the corner, and chairman Jerome Powell proposed last week The Fed may have to raise rates higher than previously expected and will accelerate growth amid signs of increased inflationary pressures in the economy.

INFLATION UP 0.4% IN FEBRUARY AS PRICES REMAIN STEADY HIGH

The hawkish comment prompted investors to rethink their expectations for the meeting, with many increasing the chances that the Fed will approve a half-percentage hike during the March 21-22 meeting.

But Wall Street no longer sees this as an option after the stunning collapse of Silicon Valley Bank on Friday, which roiled global markets and raised fears of a wider financial crash.

The Silicon Valley Bank collapsed in a liquidity crunch, forcing the government to take it over and raising questions about the fate of nearly $175 billion in customer deposits.

It was the biggest US bank failure since the 2008 global financial crisis, and rising interest rates played a key role in the collapse of the SVB, according to Treasury Secretary Janet Yellen.

“Problems with the technology sector are not at the heart of this bank’s problems,” Yellen said Sunday in an interview with CBS’ Face the Nation.

SVB Crash Throws Fed’s Decision to Raise Next Week’s Target into Uncertainty

This is because SVB, which has mainly served tech companies, venture capital firms and high net worth individuals, experienced a huge deposit boom during the pandemic, with assets rising from $56 billion in June 2018 to $212 billion in March 2023. of the year. The bank responded to this. investing most of that money in long-term US Treasury bonds and other mortgage-backed securities.

This strategy backfired when the Fed began raising interest rates rapidly and the value of those securities fell.

This coincided with a reduction in available funding for startups, which began using more of their money to cover their costs, forcing the lender to sell some of its bonds at a massive $1.8 billion loss. When the depositors realized that the SVB was in a precarious financial situation, a flight from the bank ensued.

The collapse of the bank, combined with another collapse at Signature Bank and turmoil at Swiss lender Credit Suisse, has dramatically shifted Wall Street’s rate hike bets.

MORTGAGE RATES AFTER BIG REDUCTION DUE TO SVB IMPACT

While the problems of the European lender do not seem to be related to the SVB, parallel problems have raised new concerns about the vulnerability of the banking sector in an era of high interest rates. Swiss regulators stepped in Wednesday afternoon to announce they would provide liquidity to Credit Suisse if needed.

Investors remain divided over whether the Fed will pause its rate hike cycle next week or approve a 25 basis point hike, according to CME Group’s FedWatch tool, which tracks trade. But they generally agree that politicians will cut rates later this year amid the banking sector fiasco.

Pricing in the futures markets suggests that the central bank will cut rates throughout the year, dropping a full percentage point from a peak of 4.75% to 5% by the end of 2023.

“The easing of recent inflationary pressures, coupled with concerns about the banking sector, is finally giving the Fed a reason to discuss a possible end to the tightening cycle at its meeting next week,” said John Lynch, chief investment officer at Comerica Wealth Management.

However, new data released on Tuesday morning showed that inflation remains uncomfortably high. The Department of Labor said consumer price index, a broad measure of prices for everyday goods, including gasoline, groceries and rent, rose 0.4% in February from the previous month. Prices rose 6% year on year.

While this was the lowest annual inflation rate since September 2021, the rate remains about three times higher than the pre-pandemic average, highlighting the ongoing financial burden on millions of U.S. households due to high prices.

“Federal Reserve System will have to choose their poison: tolerate some inflation for a bit to see if its current streak of rate hikes will take hold and pause or continue the climb and deal with the financial instability caused by their own policy decisions,” said Jamie Cox, managing partner at Harris Financial Group.