Unlock Premium Data: Up to 50% Off InvestingProCLAIM SALE

Fed Raises Interest Rates Despite Ongoing Banking Crisis: What’s Next?

Published 23/03/2023, 17:42

On Wednesday, 22 March 2023, the Federal Reserve continued its fight against inflation and once again raised interest rates by 0.25%. This move causes concern since the present banking crisis has developed precisely because of rising interest rates.

So far, the Fed's successful strategy for fighting inflation has been to raise the key rate and reduce the balance sheet. This negatively impacted the value of U.S. Treasury bonds and other securities, which are an important source of capital for most U.S. banks. Silicon Valley Bank was the first to fail—it was forced to quickly sell the cheaper bonds at a significant loss, leading to a liquidity crisis and eventual collapse. This was followed by Signature Bank and Credit Suisse, which had to sell off, and First Republic, which received a lifeline.

The U.S. Federal Reserve recognized its mistake and took emergency measures to support the banking system. It provided $303 billion of liquidity to banks through the Discount Window and Bank Term Funding Program (BTFP), thereby curbing the banking crisis locally.

The crisis also spread to the eurozone, with Credit Suisse failing after a 166-year run. To prevent a complete collapse, the Swiss National Bank (SNB) opened a credit line for Credit Suisse, which enabled it to take a $53.7 billion loan and stay afloat. However, it ultimately failed.

Just hours after opening the credit line, the European Central Bank (ECB) President Christine Lagarde announced a rate hike, doubling it by 50 basis points at a scheduled meeting. While investors viewed this as a positive signal for European economic stability, the rate hike decision appeared hasty and could potentially lead to an aggressive rate hike by the Fed.

At Wednesday’s meeting, the Fed showed great restraint by adhering to its baseline and raising the key rate by 25 bps, while looking to reduce the balance sheet further. The press release on the situation with the banks stated the following:

"The U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks."

Jerome Powell reported the need for continued balance sheet cuts. Commenting on the issue, the OctaFX financial market analyst Kar Yong Ang said: "It is commendable that the Fed did not cave to market pressure and maintained the course to suppress inflation. This is a crucial step that will help them curb inflation and perhaps even avoid a recession."

However, there were dovish signals in the Fed's dot plot, including a rate cut of 75 bps next year. Seeing only the growing liquidity flow, the market interpreted it as the end of the tightening monetary policy cycle, with swap markets betting that the U.S. interest rate will fall to 4.19% at the end of this year.

The banking sector is facing great risks, and the regulators' fight against inflation could make it more unstable, ultimately dragging the rest of the economy down the chain and potentially causing a global recession. Only time will tell whether this happens.

Latest comments

Loading next article…
Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.