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With only a few days left until the Federal Reserve’s next interest rate decision, US politicians are caught between stone and stone.
The recent collapse in the banking sector, sparked in part by Silicon Valley Bank collapsing under the weight of higher interest rates, has prompted some economists and analysts to call for a moratorium on rate hikes until the industry sorts itself out.
At the same time, inflation remains well above the central bank’s 2% target, economic data continues to show the strength of the jobs market and the resilience of consumer spending, and Fed officials have signaled their intention to aggressively tighten monetary policy until inflation eases.
“That means the increased inflation background [the Fed] is in a very delicate situation compared to the past 40 years,” Gregory Daco, chief economist at EY, wrote in a statement on Thursday. In recent years, the Fed has been able to respond “steadfastly” to financial risks by easing monetary policy without worrying about price stability, he said. But the conditions today are “quite different, inflation is still too high”.
So what should policymakers do at their March 21-22 meeting?
The reputation game: The question isn’t what the Fed should do, but what the Fed will do, Daco said. “And heritage can be the determining factor,” he added. “[Federal Reserve Chair Jerome Powell] and most policymakers don’t want their legacy to be not bringing inflation down to the 2% target.”
That was the view of the European Central Bank on Thursday, when President Christine Lagarde announced an aggressive half-point rate hike just hours after Credit Suisse accepted a $53.7 billion loan to stay afloat .
Lagarde chose to portray this rate hike as a signal that the financial system remains strong. The central bank has the tools it needs to respond to a liquidity crisis, “but we don’t see that,” it told reporters on Thursday.
Lagarde stressed that European banks are much more resilient than before the global financial crisis, with strong capital and liquidity positions and no concentration of exposure at Credit Suisse.
Most large banks have some degree of financial connection or relationship with other banks, either because they have lent money to, invested in, or entered into other financial arrangements with those banks. But in the case of Credit Suisse, which has been a sluggish car wreck for years, many large institutions have already distanced themselves.
The ECB’s stance opens the door for bigger rate hikes by the Fed next week.
“The implications [of the ECB hike on] next week’s Fed meeting suggests the Fed will hike rates [a quarter point] based on future probabilities, but will make clear that the stability of the banking system remains strong,” said Quincy Krosby, Chief Global Strategist at LPL Financial.
The two-pronged approach: The Fed is likely to borrow a different tactic from the ECB: carefully distinguishing its anti-inflation campaign from its work to contain financial system woes.
By implementing this two-pronged approach, “the Fed would be able to gradually tighten monetary policy further while closely monitoring developments in financial markets,” Daco said.
Under that plan, Powell would use his Wednesday press conference to emphasize the disconnect between monetary policy and the Fed’s work to mitigate the risk of cascading failures in the financial world.
The predictions: The majority of investors are betting the Fed will hike rates by a quarter point next week, although a significant minority are pricing in a pause in rate hikes, according to the CME FedWatch tool. Ahead of the current stress in the banking sector, Fed officials hinted that they would hike rates by half a point. Investors are now assuming the probability of this happening is 0%.
But Wall Street could be in for a surprise on Wednesday, some economists say.
“Markets have lowered their expectations for interest rate paths and expect central banks to come to the rescue of the economy by cutting rates as they previously did during episodes of financial stress,” BlackRock analysts wrote on Thursday. “We think this is misguided and expect the major central banks to continue raising interest rates at their meetings in the coming days to try to stem persistent inflation.”
As it always was: while he shakes The situation Powell now faces is not unprecedented, said Seema Shah, principal asset management’s chief global strategist.
“Every central bank tightening cycle in history has resulted in some sort of financial strain,” she wrote Thursday. “Until this week, markets had largely ignored the threats tightening policies were beginning to reveal. However, the recent turmoil has been a quick reminder to investors that risky assets simply cannot escape the wrath of monetary tightening.”
Eleven of the largest banks in the US have given First Republic a $30 billion lifeline to save the regional lender from the fate of its industry peers, Silicon Valley Bank and Signature Bank.
First Republic shares had slumped following SVB’s collapse last week and reports began to circulate that the bank was exploring a possible sale. On Thursday, the group of financial titans announced they would provide the bank with enough funds to meet withdrawal requests and hopefully restore some confidence in the security of the US banking system.
“This sign of support from a group of large banks is very welcome and shows the resilience of the banking system,” the Treasury Department said in a statement on Thursday.
Big banks include JPMorgan Chase, Bank of America, Wells Fargo, Citigroup and Truist.
In an opinionThe banks said their action “reflects their confidence in the First Republic and in banks of all sizes,” adding that “regional, medium-sized and small banks are vital to the health and functioning of our financial system.”
Speaking of lifelines, struggling megabank Credit Suisse could use more help to stay afloat, reports CNN’s Mark Thompson.
Banking analysts at JP Morgan said the $53.7 billion in support offered by the Swiss central bank would not be enough amid “ongoing market confidence issues” with Credit Suisse’s plan to spin off its investment bank and the erosion of the broader one business.
Clients withdrew 123 billion Swiss francs ($133 billion) from Credit Suisse in 2022 – mostly 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, the status quo is no longer an option as counterparty concerns are beginning to surface, reflected in weakness in credit/equity markets,” analysts at JP Morgan wrote in a research note on Thursday, adding, that it will be a takeover – likely by larger Swiss rival UBS (UBS) – was the most likely endgame.
Source : www.cnn.com