Fed raises interest rates by 0.25 points, as banking crisis complicates inflation

The Federal Reserve announced another 25-basis point increase in its benchmark interest rate range to between 4.75% and 5%, the highest level since 2007.

But though far from the 50 and 75 basis point increases instituted over the last year, this may have been one of the most controversial choices the Federal Open Market Committee has made.

On one side stands inflation. While slowing, it has been persistent, especially in core components. The Producer Price Index has also slowed its growth, but remains high, especially in areas like construction. New jobs have also continued to do better than people have expected. All signs that inflation is not down to where the Fed wants.

On the opposite side has been the roiling among banks. Silicon Valley and Signature Banks were closed down and are now under FDIC receivership. Depositors have been made whole, but there was no bailout of bond holders or shareholders. First Republic got bailed out by a consortium of large banks depositing $30 billion to provide liquidity. And Credit Suisse finally collapsed under its own weight and was bought by UBS.

One aspect has been that many banks have been holding long-term Treasurys and MBS and CMBS bonds. Purchased when yields were low, the jump in interest rates have created an atmosphere where, if marked to market—by, say, the need to sell to raise liquidity—banks would face a sudden drop in assets value from their balance sheets. One recent study says that these forces of higher interest rates and large percentages of uninsured deposits could threaten the existence of 186 more banks.

The Fed tried to walk a middle road with two statements:

“Recent indicators point to modest growth in spending and production. Job gains have picked up in recent months and are running at a robust pace; the unemployment rate has remained low. Inflation remains elevated,” and “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.”

Related: ‘Short and shallow’ recession in 2023, says The Conference Board

The Fed said “some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time,” which is an indication that in the very near future, the rate increases might come to an end.

“The end of the rate hiking cycle is in sight,” Jamie Cox, managing partner at Harris Financial Group, said in an emailed quote. “The Fed is trying to navigate the very narrow path between defeating inflation and destroying the economy with blunt force rate hikes–even they now know the latter is a very real risk.”