- It is believed that by the end of the year the Fed’s monetary policy will tend to relax given the pressure in Washington due to the electoral campaign.
- According to the Federal Open Market Committee of the issuing body, the strict conditions of current bank loans are likely to affect the economy.
The Federal Reserve of the United States announced a rise in reference interest rates by a quarter of a percentage point (0.25%). The regulatory body hinted that from now on it could vary the rate and percentage of the increases after an aggressive policy of adjustments started last year to try to combat inflation.
“The committee will closely monitor incoming information and assess the implications for monetary policy,” the Fed’s Federal Open Market Committee commented (FOMC in English) in a statement released Wednesday reviewed by Bloomberg.
The committee’s statement on this occasion was less emphatic than that of March, where the agency indicated that it could “be appropriate to reaffirm some additional policies” to try to control the persistent inflation that has been maintained during 2022 and so far in 2023.
The FOMC’s new approach will now take certain factors into account “to determine the extent to which additional policy reaffirmations may be appropriate.” Fed Chairman Jerome Powell told a news conference that “that’s a significant change that we no longer say we anticipate” more hikes.
Powell: “We will be guided by the incoming data”
Reporters consulted Powell about the content of the committee’s statement. They specifically asked whether Wednesday’s statement represented a signal from the agency for a possible pause in rate hikes in June.
The Fed chief responded: “So, we’ll be guided by the incoming data, meeting by meeting, and we’ll address that question at the June meeting.”
With this new increase, the Federal Reserve’s benchmark fed funds rate rises to the target range of 5% to 5.25%. This is the highest level since 2007, while at the beginning of last year it was close to zero.
The policy of progressive increases in the reference interest rates seeks to cool the economy to correct the price distortions that have been occurring due to the gigantic pandemic stimuli.
To avoid a major crisis due to the shutdown of the economy during the most dangerous period of the covid-19 coronavirus pandemic, the Fed together with the US government approved the granting of financial aid to companies and families to keep the economy running.
The result of cheap money and financial stimuli was a rise in prices in the US and the rest of the world that central banks are still trying to combat by appealing to monetarist policies.
The vote during the Federal Open Market Committee meeting was unanimous. Powell noted that all committee members offered strong support for the 25 basis point interest rate hike.
He also clarified that if the level of the rate shows that it is very high and allows inflation to be substantially lowered to the Fed’s 2% target, then an “ongoing evaluation” will be made, depending on the data that is received. However, he added that Fed officials’ current inflation outlook does not support rate cuts.
During the press conference given by Jerome Powell, stocks experienced some fluctuation, while Treasury yields fell.
Impact on the banking system
Although the high interest rate policy has detractors in the market and on Capitol Hill, Fed policymakers seem determined not to change their focus and direction. The rise in the cost of money not only impacts employment but also the banking system.
Smaller banks took a hit this year, unable to withstand the losses generated by rising interest rates. Some with exposure to cryptocurrencies affected by the crisis in the sector collapsed, as was the case with Silicon Valley Bank de California.
Another to fall was Signature Bank of New York, whose bankruptcy occurred after a strong bank run. But immediately the Fed reacted to prevent the other regional banks from getting infected.
The deposit outflow was contained by the Fed by offering depositors guarantees that their money would be returned. The agency launched an emergency line of credit for affected banks with the aim of restoring confidence in the country’s banking system.
The financial market was able to calm down after several weeks of turmoil. Although the Fed was able to resume its fight against inflation after this brief crisis caused by its aggressive monetary policy, tensions have once again reappeared in the sector.
“Solidity and resistance” of the banking system
On Monday, JPMorgan Chase & Co. announced the acquisition of First Republic Bank. The failing bank, whose shares were seized by the US government, was sold in a negotiated deal.
After the announcement, shares in other regional banks fell on fears that more small banks will perish. This has reignited the debate in Washington and Wall Street about how much longer the Fed will stick with this very high interest rate policy.
The FOMC insisted in its statement on Wednesday that “the US banking system is sound and resilient.” But not everyone agrees with the Fed committee, since the strength and resistance is greater in large banks than in small ones.
Worrying employment data
Another worrying fact is the numbers shown this week by the Department of Labor, whose monthly report shows that job offers are falling while, in parallel, layoffs rose in March.
It is a turning point for the labor market, which has already begun to suffer from the impact of the monetary adjustment. This is suggested by the most recent employment data in the US, despite the fact that throughout 2022 and the first quarter of this year, it remained firm.
Powell revealed that after the March banking crisis conditions for banks have “improved vastly”. Although he highlighted that the tensions in the financial sector “seem to be resulting in even tighter credit conditions for households and companies”.
He also noted that as a consequence of “these stricter credit conditions”, it is likely that economic activity, hiring and inflation will be affected this year. So he acknowledged that “the extent of these effects remains uncertain.”
The head of the Federal Reserve does not rule out that the US falls this year from a expected mild recession. Nevertheless he said: “in my opinion, the case of avoiding a recession is more likely than the case of having a recession.”
He explained that up to now the US economy has shown signs of great strength. While wage increases are tapering off after spiking just at the end of the pandemic and job supply has fallen, unemployment rates have not seen an increase, Powell said.
Increased political pressure
Powell’s optimism has not prevented concern in the White House. A rise in the unemployment rate in the midst of the 2024 presidential election campaign would be devastating for Joe Biden and the Democratic Party.
Already the Democratic legislators themselves are sounding the alarms. On Monday a group of senators led by Elizabeth Warren and Bernie Sanders published a letter urging Jerome Powell to stop raising interest rates.
The Fed is likely to slow down and rate hikes going forward, but there is a commitment to keep rates high until they are sure inflation has subsided and approaches the US central bank’s target for 2%.
All indications are that Fed officials will keep the interest rate above 5% this year. This is shown by the body’s projections released after the FOMC meeting in March.
The market thinks otherwise. Investors are leaning towards easing rates in the coming months. It is projected that by the end of this year interest rates should be cut by about 70 basis points.