Did SVB break the Fed? Officials mull risks of more rate increases
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[March 20, 2023] By
WASHINGTON (Reuters) - At an early January meeting of the Virginia
Bankers Association, executives were already nervous that Federal
Reserve interest rate increases were making it hard to compete for
"Everywhere I go in the industry people are feeling that kind of
pressure," the featured speaker of the day, Richmond Fed President
Thomas Barkin, said in response to a question from the audience. The
influence of Fed rate hikes "is going to hit...That is how it is
When Fed officials meet this week the suddenly urgent question is
whether the level of pressure on the banking industry has become so
great it risks a larger financial crisis - the sort of event associated
with deep and hard-to-arrest economic downturns - and warrants a
slowdown or pause to further rate increases.
The Fed and global central banks, after a tense 10 days with banks
teetering in the U.S. and Europe, launched a second round of weekend
efforts to buttress the system by expanding the Fed's ability to ship
dollars where needed. Separately a deal was struck for UBS to acquire
the troubled Credit Suisse in a takeover reminiscent of the global
financial crisis 15 years ago.
After the announcement Treasury Secretary Janet Yellen and Fed Chair
Jerome Powell issued their second Sunday afternoon statement of
reassurance in as many weeks, saying as Asian markets prepared to open
for the week that "the capital and liquidity positions of the U.S.
banking system are strong, and the U.S. financial system is resilient."
The issue for Powell and his colleagues is whether the calming words and
a bank lending new program are enough to stem broader problems and allow
them to proceed with what has been their priority to now: Combating
inflation with the ever-higher interest rates now bedeviling the banking
If banking stress was to some degree hiding in plain sight, with
deposits falling since the middle of last year and some common bank
assets losing value as interest rates rose, the flashpoint was not hit
until March 10 when the failure of the Silicon Valley Bank triggered
doubts about the health of a swath of mid-sized banks and raised
concerns of an old-fashioned deposit run.
Economists and investors so far expect the Fed to proceed with another
quarter point interest rate increase at its March 21-22 meeting, but
only because inflation poses such a persistent risk policymakers won't
want to divert from efforts to control it. The financial system,
meanwhile, has been thrown extra support under a new Fed lending program
for banks, while its traditional lender-of-last-resort cash window was
tapped for a record $150 billion.
Fed officials gather this week having agreed bank stress poses a
"systemic risk" to the economy, and "in any other hiking cycle
this...would end the tightening process and perhaps send it into
reverse," said Ed Al-Hussainy, senior rates analyst at Columbia
Threadneedle Investments. "The difference today is the Fed's focus on
In a recent Reuters poll 76 of 82 economists said they expect the Fed to
approve a quarter point rate increase at this week's meeting, lifting
the target federal funds rate to a range between 4.75% and 5%. A
similarly strong majority expect a further increase at a future Fed
The Fed's policy statement will be released Wednesday at 2 p.m. (1800
GMT) along with closely watched projections from officials for the
policy rate at year's end, perhaps the best clue to how recent financial
stress has reshaped the Fed's outlook.
As of December officials expected the policy rate would rise to around
5.1% by year's end.
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The U.S. Federal Reserve building is
pictured in Washington, March 18, 2008. REUTERS/Jason Reed
Worried about losing control over inflation that hit a 40-year-high
9.1% in June, the Fed over the past 12 months increased rates at the
fastest pace since former Fed Chair Paul Volcker faced an even worse
outbreak of hot prices.
The experience of 1970s-era central bankers informed not only the
extent of the rate increases, with the policy rate rising 4.5
percentage points from near zero as of last March. Powell and his
colleagues also insisted the lesson from decades ago was that rates
needed to rise to a restrictive level then stay there until
inflation was defeated -- not "stop and go" in a pattern of hikes
and cuts they felt would not achieve price stability.
To many officials, the fact that inflation has been slow to respond
to higher rates, while the economy has continued to grow and spin
out hundreds of thousands of new jobs a month, was evidence rates
needed to move higher still. Because nothing had "broken" in the
economy, further rate increases were seen as cost-free.
On March 10 something broke, symbolically in the failure of the
country's 16th largest bank, but more broadly in the perception that
the system might not be as stable as Fed officials have felt in the
years since regulatory reforms forced financial firms to better
None of those reforms prevented SVB from funneling its rapidly
growing deposits into long-term government bonds that lost value as
the Fed raised rates. That left the firm potentially short of the
cash needed when depositors began to demand withdrawals -- a dynamic
the Fed worried could spread to other banks facing similar
For Fed policymakers the episode raises the possibility that they
have repeated a mistake they had sworn to avoid and gone too far in
The Fed's recent policy statements have said that rate decisions
would take into account "the lags with which monetary policy affects
economic activity and inflation," but until now respect for the
delayed impact of past rate hikes has done little to change the
Economists last week began marking down their growth forecasts
anticipating that banking stress means a credit contraction lies
ahead, with less money in the pockets of homeowners and businesses.
To a degree that is what the Fed wants when it tightens monetary
policy, as long as the drop in lending is orderly and doesn't go too
"We expect that stress on smaller banks could result in a tightening
of lending standards, exerting an incremental growth drag" on gross
domestic product of as much as a half point, Goldman Sachs analysts
wrote last week, among the few outside forecasters to say they
expect the Fed to pause its rate hikes to take stock.
Markets are hardly settled. Even with a separate intervention by
bank industry giants to shore up the books of the First Republic
Bank, shares of the lender plummeted Friday amid broader stock
market losses. The Fed has announced a review of its supervision at
SVB to see if warning signs were missed.
Still, for the Fed "to pause here would provide no relief to the
idiosyncratic issues for banks, and the Fed would risk losing all of
the hard-fought progress made" in defending its 2% inflation goal,
wrote Jefferies analyst Tom Simons. "The optics of a pause remains
(Reporting by Howard Schneider; Editing by Andrea Ricci and Dan
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