Over the past month, US Federal Reserve chair Jerome Powell has renewed the central bank’s commitment to continue tightening monetary policy amid indications of a slower than expected return to price stability.
He recently told the US Senate the “ultimate level of interest rates is likely to be higher than previously anticipated” in lieu of “stronger than expected” economic data.
“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” Mr Powell added.
But the Federal Reserve’s rate strategy could be set to shift in lieu of new financial stability concerns heightened by the collapse of Silicon Valley Bank (SVB).
The California-based bank’s collapse has been attributed to aggressive monetary policy tightening, its high exposure to long-term bond yields, weak deposit inflows, and subdued investor sentiment in the tech industry (the core of its customer base).
SVB’s failure has sparked concerns over “contagion risks” prompting a swift response from the Fed, Treasury, and Federal Deposit Insurance Corporation (DSIC).
The regulators stepped in to fully protect the funds of SVB depositors and launched a one-year funding facility to “help assure banks have the ability to meet the needs of all their depositors”.
These measures are expected to be supported by a slowdown in monetary policy tightening, with the Fed now tipped to reduce the size of its next hike to the funds rate from 50 bps to 25 bps.
“Rather than proceeding with more monetary tightening on 22 March and 3 May, the Fed finds itself in a terrible bind,” Eric Vanraes, portfolio manager of the strategic bond opportunities fund at Eric Sturdza Investments, observed.
“…It is highly probable that there will be no 50 bps increase in Fed funds on 22 March. The worst-case scenario would be a rate cut, but we think it is far too early to contemplate that.”
Vanraes said over the longer-term, “tremors” in the US banking system would likely “kill off” the Fed’s large rate hikes.
“Central bank hawkishness in such an environment would be a reminder of 1992, when the Swedish Riksbank raised rates to break a speculative devaluation of the Swedish krona,” he continued.
“The move successfully defended the currency on foreign exchange markets, at the cost of bankrupting its banking system.”
ING Economics agrees, adding if the US financial system is “materially threatened”, the Fed “could not hike at all”.
“We only have to look at the global financial crisis and the pandemic as templates that showed the Fed is single-minded when the system is under threat, and that is to cut rates and ease policy, significantly,” ING Economics observed.
