Raise the key federal funds rates by 25 or even 50 basis points or opt for the status quo? This is the question that the members of the Fed’s Monetary Policy Committee (FOMC) will have to answer on Wednesday, as they meet on Tuesday for two days. Two weeks ago, during a hearing in Congress, its president, Jerome Powell, had mentioned a quarter and a half point among the options on the table, justified by a still dynamic labor market, the increase in spending on households and, above all, a level of inflation which stood at 6% over one year in February.
Black sequence
But since this hearing, the banking sector on the other side of the Atlantic has experienced a black series which has plunged the financial markets of the whole planet. Triggered on March 10 by the spectacular bankruptcy of Silicon Valley Bank (SVB), the sixteenth largest bank in the country, followed by the fall of two other establishments in the United States, it spread to Europe, with the fall of the Credit Suisse on March 19, which resulted in its takeover by UBS, another Swiss bank.
“Given the market turmoil, the outcome of the FOMC meeting is therefore more open than ever. Ten days ago, we said to ourselves that the Fed would have to choose between an increase of 25 or 50 basis points. After Jerome Powell’s hearing in the Senate on March 7, this last option even held the line in market expectations. This is no longer the case after the fall of SVB”notes Bruno Cavalier, chief economist at Oddo-BHF.
The monetary institution of the United States finds itself today on a ridge line bordered on one side by its commitment to curb the inflation which weighs on households and businesses and on the other side by the imperative to prevent the banking crisis, the worst since 2008, from getting worse.
Contagion contained
Because even if the contagion was contained thanks to the coordinated intervention of central banks which avoided a liquidity crisis, doubt persists. “Last week’s injection of liquidity (both the central bank’s coordinated swaps and the $300 billion borrowed from the Fed by cash-strapped US banks) could temporarily help the banking sector. But this cash will not go to the real economy. In the case of borrowed money, I don’t anticipate that those bank reserves will be largely lent out. I bet the banks will slow down credit instead”warns William Gerlach, analyst at iBanFirst.
Goldman Sachs has even calculated that tightening lending conditions due to industry stress would be equivalent to a quarter or half point hike in the Fed’s benchmark rate. An argument for the status quo on Wednesday.
The cause of the banking sector’s difficulties stems from the rapid and continuous rise in key rates since 2022. It mechanically devalues the market value of the assets of many banks invested in sovereign and corporate bond securities or even in mortgage loans, all the more so if this risk is not covered, as evidenced by the misadventure of SVB.
“The problems in the banking sector illustrate how the real economy is reacting to the Fed’s monetary tightening cycle. The risk is that the tightening of financial conditions and the resulting decrease in liquidity will amplify previously unidentified vulnerabilities in other markets.judge Stéphane Monier, CIO of Lombard Odier.
Doubt is indeed the poison that seeps into the entire sector and threatens all economic activity, particularly in the United States. “If the Fed doesn’t stem the collapse of regional banks, the problem could be much deeper. Small and medium banks account for 50% of commercial and industrial loans in the United States, 60% of residential real estate loans, 80% of commercial real estate loans and 45% of consumer loans”recalls John Plassard at Mirabeau Equity Research.
Release pressure and temporize
Members of the Fed committee have this data in mind. They could push them to release the pressure and procrastinate. “Will the Fed set the stage for a lull on the rate hike front? Nothing is less sure. The exercise will in any case be delicate. The institution will have to juggle between inflation that is still high, with +0.5% in February on a monthly basis for the core CPI [hors prix de l’énergie et de l’alimentaire]and the threat of possible financial contagion”considers for his part Thomas Giudici, head of bond management at Auris Gestion.
The choice is all the more difficult as the fight against inflation has already weakened part of the banking sector. “In the United States, banks account for about 40% of private credit. And for SMEs, which have a particularly large macroeconomic footprint, bank tightening is a major problem. While it is too early to announce a recession in the United States, the risk has intensified considerably over the past few days”avers William Gerlach.
However, does taking a break represent a major risk in the current context? “A 25 basis point hike can be a compromise choice. For the future, all options remain open. After all, inflation is neither lower nor less persistent today than it was a week ago”notes Bruno Cavalier.
A 25 basis point hike makes it possible to hold both ends of the equation: not to give the impression that the fight against inflation is taking a back seat while giving yourself a break to see how the situation will develop , at least until the next meeting. Because the economy remains robust in the United States, as evidenced by the labor market. The unemployment rate was 3.6% in February, up from January when, at 3.4%, it was the lowest for 50 years.
The ECB stuck to the planned agenda
For its part, last week the ECB stuck to the planned agenda by raising its key rates by 50 basis points, a decision justified by its president, Christine Lagarde, by the need to stay the course in the fight against inflation. On the other hand, she was careful not to make a commitment for the next meeting.
The Fed had not made a commitment at its last meeting, wanting to be pragmatic and cautious because of the events that have complicated its forecasts. Yesterday, the war in Ukraine, which continues, today, the banking crisis.
“I think the Fed will raise rates by 25 basis points, while indicating that it is ready to support the banking system if necessary. The Fed remains very concerned about the outlook for inflation and will therefore try to demonstrate that it is able to contain financial stability risks with one set of tools, while fighting inflation with another”also abounds Luke Bartholomew, economist at abrdn.
For Jerome Powell, it will above all be necessary to prove on Wednesday during his press conference that he has the compass which points him in the right direction to get out of the fog of uncertainty in which the banking and financial sector is plunged today.