With Two Bank Failures, Will the Fed Gear Back Rate Hikes?

The failures of Silicon Valley Bank and Signature Bank seemed to be wake-up calls. The immediate question to many is what effect this might have on the Federal Reserve and decisions to change interest rates.

Just last week, in his semiannual testimony to Congress, Fed Chair Jerome Powell invoked the dual mandate of promoting maximum employment and stable prices — and no word of supporting asset prices.

“Fed Chair Jerome Powell used his semi-annual testimony to push back against financial markets as his comments were hawkish, noting that the terminal rate for the fed funds rate could be higher than previously anticipated,” Oxford Economics said in an emailed note. “He noted that he isn’t hesitant to increase the pace of rate hikes if the data on employment and inflation continue to come in stronger than anticipated.”

That came before another strong jobs report, although unemployment rose from 3.4% to 3.6%, effectively having numbers for the same concept going in two directions at the same time.

The large consensus at the time was that a 25-basis point increase was probably in the cards, with a “half-point increase in March if data on inflation and labor conditions continue to run hotter than expected,” said Marty Green, a principal with mortgage law firm, Polunsky Beitel Green, in an emailed note.

Then came multiple banks collapsing and being closed. Critics of the Fed pointed to the impact of high and swift interest rates on the banks. Nobel laureate economist Joseph Stiglitz wrote that the collapse of SVB at least owed in part to “Powell’s callous – and totally unnecessary – advocacy of pain.”

It is also true that SVB and Signature had significant risk management problems compounded by the past regulation reduction that happened in 2018, allowing them to do things without regulators being allowed to ask questions they would of a larger bank. A regulatory downscaling that, as Stiglitz noted, Powell was part of Donald Trump’s administration and worked on the team that looked to weaken regulatory coverage of “smaller” banks.

However, in addition to the dual mandate, the Federal Reserve is also one of the banking regulators in the US. As multiple experts have pointed out, the banking industry as a whole is a large holder of Treasurys because they are considered safe. But their value can fluctuate with interest rate changes. Banks can treat these assets in one of two categories: available-for-sale (AFS), or hold-to-maturity (HTM). When a bond is held to maturity, it doesn’t get regularly compared to market rates, allowing a bank to not address what the current value is on its balance sheet. But sell one of those bonds to raise capital and they all become subject to reexamination.

SVB held an unusually large percentage of long-term bonds, whether Treasurys or mortgage backed securities. They had had grown rapidly during the pandemic, as the Wall Street Journal shows, as investments flowed into tech companies that deposited it with the bank. But the Fed may be nervous about how its rates could impact all banks. Is there a point at which more institutions would start to fail? Then again, back off and the result might be inflation heating up.

The Fed could leave rates where they are, reduce them, increase them as expected, or bump them up even faster. With the opposing pressures, it might be that keeping things steady with 25-basis point rate increases, or a pause, would be the safest choice.