Fed set to hike rates by 25 basis points despite turmoil in US banking sector
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The Federal Reserve is expected to raise interest rates for the ninth time in a row later this week despite widespread instability in the US banking sector.
According to Fedwatch there is a 62 per cent chance that the Fed will opt for a 25 basis point hike and 38 per cent chance that it will keep rates flat.
As analysts at ING summarised, “while the most prudent course of action may be to pause and digest the fallout from regional banking woes, the Federal Reserve is focused on inflation and will look to hike 25bp if conditions allow.”
Although the 25bps hike would be a climbdown from the 50bps which many were predicting after Jay Powell’s Senate hearing a week ago, it would continue the policy of monetary tightening which has sparked financial turmoil in the US over the past few weeks.
The decision comes at a critical juncture for the US financial system which is still reeling from the collapse of Silicon Valley Bank (SVB).
US banks, particularly smaller regional lenders, have looked shaky despite big government interventions to prop up the system.
Following SVB’s collapse, regulators in the US stepped in to insure all deposits at SVB, even those above the $250,000 limit, and offered emergency lending to embattled banks.
Despite this, a number of small banks continued to see steep share price declines and an exodus of depositors. This was most prominent at First Republic Bank, which has a high proportion of uninsured deposits, and looked like it would be the next bank to collapse.
First Republic’s share price has fallen over 70 per cent since SVB’s collapse, prompting Wall Street’s biggest lenders to step in with a $30bn support package. This failed to arrest First Republic’s slide with its share price falling 33 per cent the day after the intervention.
The picture amongst US banks is not bright. The Fed has lent over $300bn to cash strapped banks in the past week. Deposits have flooded out to larger more stable banks with Wells Fargo banking analyst Mike Mayo writing in a research note that “Goliath is winning.”
A coalition of midsize banks has asked the Federal Deposit Insurance Commission to insure deposits for two years in an attempt to staunch the outflows. If the outflows continue, it will tighten monetary conditions even further as it will constrain smaller banks’ ability to lend.
As ING analysts explained, “the stresses created by the SVB fallout will only make banks more nervous about who they lend to, how much they lend and at what interest rate. With regulators also likely sensing a need to be more proactive, this could lead to a snowball effect of risk aversion and tightening of lending standards that hampers credit flows.”
The Bank of England will also announce its decision later this week facing many of the same decisions as the Fed.
While markets were anticipating a 25bps hike, some now expect the Bank to keep rates steady. Analysts at Investec said “a pause seems to be the most likely outturn, although that does not necessarily imply that tightening has finished”.
The Fed’s decision comes the week after the ECB hiked interest rates by 50 basis points despite European financial instability. President of the ECB Christine Lagarde justified the decision saying there is “no trade off between price stability and financial stability”.