Federal Reserve Expected to Hike Rates Next Week, Despite Shaky Banks

A slight dip in inflation and new Washington safeguards for lenders seem to have reassured investors, for now.

That dreaded occurrence, bank failure, evokes visions of the 2008 financial crisis, which almost torched the global financial system. But the fear of cataclysm seemed to have faded Tuesday—and thus talk has ebbed that the Federal Reserve will go easier on anticipated interest-rate hikes.

When the Fed’s policymaking body meets March 21-22, the futures market is split over whether the Fed will do  a quarter-point rate increase or stand pat, although most analysts side with the quarter-point scenario. Just the week before, the betting strongly (by almost 70%) favored a half-point boost. It’s significant that, even after the government takeover of Silicon Valley Bank and Signature Bank, the Fed is not expected to pause in its tightening campaign.

What propelled projections of a quarter-point March action was a slowing of the Consumer Price Index’s growth, to a 6% annual pace in February from 6.4% the year before. The slight deceleration—face it, the level still is high—was sufficient to keep the continued-increases narrative going, according to Jeffrey Roach, chief economist for LPL Financial.

“Even amid current banking scares, the Fed will still prioritize price stability over growth and likely hike rates by 0.25 [percentage points] at the upcoming meeting,” he noted in a statement. “Investors should expect inflation to improve in the latter half of this year.”

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No doubt, Washington’s “non-bailout” bailout of the two failed banks, plus the Fed’s creation of a lending facility for troubled lenders, has helped soothe worried investors. Although Treasury Secretary Janet Yellen on Sunday told CBS’ “Face the Nation” that there would be no major bank bailout, her department,  the Fed and the Federal Deposit Insurance Corporation announced on the same day that depositors at SVB and Signature would be made whole.

The standard cap per deposit on FDIC coverage is $250,000, but affected depositors will get all their money back, even if it exceeds that threshold. Stock and bond investors in the banks are getting no help at all from the government.

The stock market seemed encouraged Tuesday, as the S&P 500 rose 1.65%, snapping a five-day losing streak driven mainly by the bank woes. Bank stocks eclipsed the larger market: The KBW Nasdaq Bank Index leapt 3.5%. In early trading Wednesday, both the broad market index and the bank index gave up those gains, amid fresh concerns with another troubled bank, Credit Suisse.

No surprise. Few believe that banks are out of the danger zone. On Tuesday, Moody’s Investors Service lowered its view on the entire banking system to negative from stable. Moody’s also has downgraded Signature—withdrawing its credit rating—and put six other regional banks on watch for possible downgrades, including First Republic, Intrust Financial, UMB, Zions Bancorp, Western Alliance and Comerica. For those six, the agency said it was concerned about deposit outflows and reductions in their assets’ market worth.

Much of their plight stems from the Fed’s energetic tightening as it moved, perhaps belatedly, to fight rising inflation. “We got into this mess because a lot of central banks and a lot of economists [and] the Fed started to believe that inflation was largely dead,” Ethan Harris, head of global economics research at Bank of America, said on Bloomberg Television. “Now we’re seeing a massive catch-up.”

That catch-up, the Fed’s quick elevation of rates from near-zero since 2022, led to severe decreases in the price of bonds that SVB held on its books. Because those reductions resulted in a lower capital ratio, the bank had to scramble to plug the hole by selling assets at prices far below their value. “SVB’s liquidity risk management practices were deficient,” wrote Clifford Rossi, a professor at the University of Maryland’s Robert H. Smith School of Business.

Another weakness, he pointed out, was that SVB concentrated on venture capital lending, and this tech-centric segment has been suffering for months—and its companies needed to pull deposits out of SVB to pay their bills. 

Signature had another over-concentration problem: It was a big lender to cryptocurrency businesses. That asset class, of course, has crashed spectacularly of late.

Rossi wrote: “SVB’s stunning collapse is a reminder that despite our best efforts to regulate the banking sector following the 2008 financial crisis, banks can and will fail from time to time.”

Assuming the Fed does not view this disturbance in one corner of the banking industry as indicative of a larger problem, then a quarter-point hike seems reasonable.

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