Market Update – Fed’s latest interest rate hike amid a banking crisis.

It’s Fed day—and it’s a big one. The central bank faces one of its hardest calls in years: keep raising rates to fight inflation or hold steady to help quell the worst banking crisis.

In a statement released Wednesday, the Federal Reserve raised its benchmark interest rate target range by 0.25%. This is at its highest level since October 2007, as the central bank is grappling with stubborn inflation and a banking crisis, which have prompted the expansion of emergency measures since the onset of the pandemic.

It brings the Federal Reserve’s policy rate to a new range of 4.75%-5%. It was the ninth straight time the Federal Reserve had raised interest rates in an effort to reduce liquidity in the financial markets and tame inflation.

The main question here is how much further the Fed will raise rates and how deep an ensuing recession could become. How many more rate hikes will the Fed sneak in before the economy starts to crumble?

In addition to driving financial distress among U.S. banks, the Fed’s benchmark interest rate is a contributing factor. It is worth mentioning that despite the recent collapse of Silicon Valley Bank and Signature Bank in a span of a week yet the Fed rejected concerns about the financial system. “The U.S. banking system is sound and resilient,” the central bank said in a statement.

“The recent turmoil in banking subsided and there was enough normalcy in financial markets that the Fed was comfortable with a ninth interest rate hike.” – Greg McBride, CFA, Bankrate chief financial analyst.

The Fed has not only raised interest rates but has also sold off a large portion of its bond portfolio due to the inflationary environment. As the Fed runs off its balance sheet, the move serves to drain liquidity from the financial system in an effort to slow inflation by draining liquidity from the financial system.

At around 3.6%, the 10-year Treasury note is now well below its 52-week high of 4.33 % that was reached in October 2022, which is quite a distance from its current level. In light of recent bank failures and even as the Fed raises short-term rates, the slide in that yield suggests that investors are preparing for a recession in the near term and anxiety about the financial system’s stability in the years to come as the Fed continues to raise short-term rates.

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Rate hikes have pushed up the cost of borrowing for consumers.

Since November, credit card rates have been breaking records, hitting 20.04% on March 8. According to Bankrate data, the average 30-year fixed-rate mortgage has climbed more than 2 percentage points since the Fed’s first rate hike in March 2022.

Additionally, the higher borrowing costs make it harder for consumers to afford anything due to price hikes on everything from food, furniture, and appliances to car repairs.

“The Fed’s decision to raise interest rates again given the fragile stability in the banking system is disappointing,” tweeted Mark Zandi, chief economist of Moody’s Analytics.

It’s unnecessary. Growth is slowing and with banks sure to aggressively tighten their lending standards due to their recent scare, growth will slow substantially more. Inflation is also moderating, and this will continue given low oil prices, weak rents and slower wage gains.
— Mark Zandi (@Markzandi) March 22, 2023

Is inflation going down from the Fed's interest rate hikes?

There has been a sharp drop in monthly job growth in the U.S. since January, going from 517,000 to 311,000 in February, while wages and salaries in the private sector grew by 4.6% over the past year, suggesting that inflation may be on the decline.

The impact of 5% rates, and what could happen if the increase continues?

Inflation is running at 6% and rates are at almost 5%. In the near future, rates are likely to rise above inflation and remain there for some time. Because historically, interest rates always remain above inflation unless a recession occurs.

Scenario A is where rates remain higher than inflation for a long period of time. That will cause a tectonic shift in markets. The attraction of equities and credit fades considerably if investors can earn interest above inflation without risk.

In scenario B, we experience a recession.

Global Reaction.

Despite recent turmoil in Switzerland’s banking sector, the Swiss National Bank increased its policy rate by 50 basis points. This took the rate to 1.5%.
On Thursday, the Hong Kong Financial Authority (HKMA) raised the base charge for its instant fee window by 25 points to 5.25%, hours after the U.S. Federal Reserve raised its rate by the same margin.
Announcing its monetary policy at 8:00 am ET is next on the agenda for the Bank of England. Economists expect rates to rise in March by 25 basis points to 4.25 percent.

The dollar and rivals reaction.

After Wednesday’s Fed meeting, the U.S. dollar traded lower against other major rivals.

Today’s Asian session saw the U.S. dollar fall to nearly 1-1/2 month lows of 130.41 against the yen and 0.9145 against the Swiss franc, down from yesterday’s closing quotations of 137.37 and 0.9173. The dollar will likely find support around 128.00 against the yen, and 0.90 against the Swiss franc.

Against the euro and the pound, the dollar dropped to 1.0905 and 1.2324 from yesterday’s closing quotes of 1.0855 and 1.2262, respectively. If its downtrend is prolonged, it is likely to find support around 1.10 against the euro and 1.25 against the pound.

It is unfortunate that the economy will slow much more quickly than inflation, so we will feel the pain well before we benefit.

References:

Federal Reserve issues FOMC statement

Federal Open Market Committee – The next Federal Reserve meeting will be held from May 2-3

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