The collapse of the banks put the Fed in trouble | CNN affairs


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With only days left until the next Federal Reserve rate decision, US policymakers are caught between a rock and a hard spot.

The recent collapse of the banking sector, caused in part by the collapse of the Silicon Valley Bank under the weight of higher interest rates, has led some economists and analysts to call for a moratorium on rate hikes until the sector recovers itself.

At the same time, inflation remains well above the central bank’s 2% target, economic data continues to demonstrate the strong labor market and consumer spending resilience, and Fed officials have signaled their intention to aggressively tighten monetary policy until price increases ease .

“The increased inflation means that [the Fed] is in a very delicate situation compared to the past 40 years,” Gregory Daco, chief economist at EY, wrote in a note Thursday. In previous years, the Fed has been able to respond “unflinchingly” to financial risks by easing policy without concern for price stability, he said. But today’s conditions are “very different with inflation still too high”.

So what should policymakers do at their March 21-22 meeting?

The reputation game: The question is not about what the Fed should do, but what the Fed will do, Daco said. “And legacy may be the determining factor,” he added. “[Federal Reserve Chair Jerome Powell] and most policymakers don’t want their legacy to be a failure to bring inflation back to the 2% target.”

That was the view of the European Central Bank Thursday when President Christine Lagarde announced an aggressive half-point rate hike just hours after Credit Suisse accepted a $53.7 billion loan to keep it afloat.

Lagarde chose to portray that rate hike as a signal that the financial system remains strong. The central bank has the tools to respond to a liquidity crisis if necessary “but this is not what we are seeing,” she told reporters on Thursday.

Lagarde stressed that European banks are much more resilient than they were before the global financial crisis, with strong capital and liquidity positions and no concentration of exposure to Credit Suisse.

Most major banks have some degree of financial affiliation or relationship with other banks because they have lent money to those banks, invested in them, or entered into other financial agreements. But in the case of Credit Suisse, which has been a slow-moving car wreck for years, many large institutions have already distanced themselves.

The ECB’s stance opens the door to bigger rate hikes from the Fed next week.

“The implications [of the ECB hike on] next week’s Fed meeting suggests the Fed will raise rates [a quarter point] based on the probability of the future, but will demonstrate that the stability of the banking system remains strong,” said Quincy Krosby, chief global strategist at LPL Financial.

The two-track approach: The Fed will likely borrow another tactic from the ECB: carefully distinguishing its anti-inflation campaign from its work to contain the financial system’s woes.

By implementing this two-pronged approach, “the Fed would be able to gradually tighten monetary policy while closely monitoring developments in financial markets,” Daco said.

Under this plan, Powell would use his press conference on Wednesday to emphasize the disconnect between monetary policy and the Fed’s work to reduce the risk of successive bankruptcies in the financial world.

The predictions: The majority of investors are betting the Fed will raise rates by a quarter point next week, though a significant minority are pricing in a pause in rate hikes, according to the CME FedWatch tool. Prior to the current banking sector stress, Fed officials hinted they would raise rates by half a point. Investors now think the chance of that happening is 0%.

But Wall Street could surprise Wednesday, some economists say.

“Markets have lowered their expectations of interest rates, expecting central banks to bail out the economy by cutting interest rates as they used to do during periods of financial stress,” BlackRock analysts wrote Thursday. “We think that’s the wrong choice and expect major central banks to raise interest rates at their meetings in the coming days to try and contain ongoing inflation.”

Same as it once was: during shock, the situation Powell now faces is not unprecedented, said Seema Shah, chief strategist at Principal Asset Management.

“Every central bank tightening cycle in history has led to financial tension,” she wrote Thursday. “Until this week, markets had largely ignored the threats that tightening policies had begun to expose. However, the latest turmoil has quickly reminded investors that risky assets simply cannot escape the wrath of monetary tightening.”

Eleven of the largest banks in the US have extended a $30 billion lifeline to First Republic Bank in a bid to save the regional lender from the fate of its peers, Silicon Valley Bank and Signature Bank.

Shares of the First Republic had plummeted last week in the wake of the collapse of the SVB and reports began circulating that the bank was exploring a potential sale. On Thursday, the group of financial titans announced they would inject the bank with enough cash to meet demand for withdrawals and hopefully restore some confidence in the safety of the US banking system.

“This statement of support from a group of major banks is very welcome and shows the resilience of the banking system,” the Treasury Department said in a statement on Thursday.

The major banks are JPMorgan Chase, Bank of America, Wells Fargo, Citigroup and Truist.

In a statement, the banks said their action “reflects their confidence in First Republic and in banks of all sizes,” adding that “regional, medium and small banks are critical to the health and functioning of our financial system.”

Speaking of lifelines, beleaguered megabank Credit Suisse may need more help to stay afloat, reports CNN’s Mark Thompson.

JP Morgan’s banking analysts said the $53.7 billion support from the Swiss central bank would not be enough given the “ongoing market confidence issues” with Credit Suisse’s plan to spin off its investment bank, and the erosion of wider activities.

Customers withdrew 123 billion Swiss francs ($133 billion) from Credit Suisse in 2022 – mainly in the fourth quarter – and the bank reported an annual net loss of nearly 7.3 billion Swiss francs ($7.9 billion) in February, the largest since the global financial crisis in 2008.

“In our view, a status quo is no longer an option as counterparty concerns begin to emerge, as evidenced by the weakness in credit/equity markets,” JP Morgan analysts wrote in a research note Thursday, adding that a takeover — likely by larger Swiss rival UBS (UBS) — was the most likely endgame.

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