As Everyone Expected, the Fed Raises Interest Rates Another 25 BP

As expected by virtually every expert that GlobeSt.com has heard from for weeks, the Federal Reserve’s Federal Open Market Committee (FOMC) announced that it would raise the benchmark federal funds rate range 0.25 percentage points to 5% to 5.25%.

Given the three bank failures in two months and concerns that further actions could tip the economy into recession, this has been a more criticized interest rate decision than several preceding ones.

The Fed said that it approved the latest increase in “support of these goals” to “achieve maximum employment and inflation at the rate of 2 percent over the longer run.”

“Economic activity expanded at a modest pace in the first quarter,” the agency said. “Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated.”

While the pace of job gains has slowed, unemployment has hovered around where it has been rather than the 4.5% the Fed projected in its March economic statement for the current year. Inflation, especially core figures, are still significantly above the 3.3% projected for 2023.

“The latest interest rate hike by the Federal Reserve is unnecessary and harmful,” wrote National Association of Realtors Chief Economist Lawrence Yun in an emailed statement. “Consumer price inflation has been decelerating and will continue this trend. After the awful 9% consumer price inflation in the summer of last year, the latest data shows 5% inflation. It will be even lower as the heavyweight component to inflation, which is housing rent, will inevitably slow down given the 40-year high robust construction of new empty apartment units. In addition, there is significant additional monetary policy tightening already occurring.”

Then it continued, “The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.”

The statement about the banking system may make some scratch their heads, at least. The Federal Deposit Insurance Corporation took First Republic Bank into official receivership on Monday and then sold it to JPMorgan Chase, as it had sought bids the previous week to take over the struggling institution.

As the Federal Reserve’s postmortem specifically on Silicon Valley Bank noted, SVB failed “because of a textbook case of mismanagement by the bank,” which didn’t “manage basic interest and liquidity risk.” Among other issues, assets held in long-term bonds could only be treated at their purchase value so long as the bank wasn’t trying to sell them. But as interest rates kept rising, the bonds’ values dropped. As large deposits were pulled out of the bank, it eventually lacked the liquidity to meet its liabilities (including deposits, which are owned by the depositors), and so was insolvent. Each upward move of interest rates only exacerbates the issue for many banks.

Also, according to the Fed, over time, bank supervisors “did not fully appreciate the extent of the vulnerabilities” of the banks and then they didn’t act swiftly enough. That includes the Federal Reserve itself.

“The fast rate hikes by the Fed have upended the balance sheets of many small regional banks,” Yun continued. “They are becoming zombie-like banks, unable to lend even to good businesses as they are more concerned with balance sheet shuffling for survival. This situation will worsen with each additional rate hike by the Federal Reserve. Only by stopping the rate hikes or even a reversal later in the year after verifying much calmer inflation rates will the small banks have a better chance of survival against the big banks.”

What will happen over the rest of the year is a tug-of-war according to some experts. In the press conference, Chair Jerome Powell was asked whether this would be the last rate hike. He answered, “That’s going to be an ongoing assessment … We’re going to have to see data accumulating.”

“As expected, the Fed raised .25% today and the market is trying to digest and dissect the data and language for guidance,” said Gina Bolvin, president of Bolvin Wealth Management Group, in a written statement. “Powell won’t blink. However, the market is pricing in rate cuts by the end of the year so the tug of war between the two—Powell and investors—continues. The remaining question is how much the regional bank crisis and credit crunch will slow the economy.”