New York, Frankfurt The stumble of several small US banks puts the US Federal Reserve in a difficult position. On Wednesday, central bankers decided to raise the key rate again, this time by a moderate quarter of a percentage point, despite persistent fears of a banking crisis. Economists see the world’s most powerful central bank caught in a conflict of interest. The Fed is still emphasizing its determination to fight inflation – but the turbulence in the banking sector is leaving its mark on monetary policy and fears of a new financial crisis are still not over.
In its statement, the central bank had to balance three influencing factors, says Frederik Ducrozet from Pictet Wealth Management: its two official mandates, maintaining price stability and safeguarding jobs, and “the unofficial third mandate, safeguarding financial stability”.
“We considered a rate pause in the days leading up to the meeting,” Fed Chair Powell conceded after the rate decision. But because inflation was higher and the labor market stronger than expected, monetary policymakers decided to stay the course.
The crisis in smaller and regional lenders in the US gets fuel with every interest rate hike, enticing investors to withdraw their funds from banks and park them in the money market, where it is more lucrative. According to many experts, this is currently the sore spot in the US financial system.
Roubini: “Commercial properties vulnerable”
Well-known hedge fund manager Bill Ackman, who has repeatedly called for a temporary government guarantee for bank deposits in recent days, once again pointed to this problem. Citigroup emphasizes that the banking system remains “fragile,” it will take time to fix, and the crisis is big enough to have an impact on the economy.
Nouriel Roubini, a professor at the Stern School of Business in New York, fears a credit crunch for the United States, as he said at an event in Frankfurt. He pointed to over $600 billion in unrealized losses in the US financial system. He warns that market risk, which is currently the focus, could quickly become credit risk.
“The small and medium-sized banks are very important for the supply of credit, and if deposits are lost there, there will be problems,” he said. “It would not make sense to issue a limited guarantee for all deposits,” he is convinced. “Any company that acts responsibly will now try to invest larger sums safely.”
He also emphasized: “The area of commercial real estate is particularly vulnerable, also because a lot of work has been shifted to the home office.” On the other hand, he calms things down to a certain extent: “Private builders usually have long loan terms, which mitigates that Problem.”
Confused Investors
Many investors are confused after Wednesday’s rate hike. Expectations about the future monetary policy course of the Fed are again widely divergent. There is agreement that Powell has succeeded in carefully tightening monetary policy. Apparently, a “peak”, i.e. a peak in interest rates, is at least in sight. Otherwise, many question marks remain.
Any company that acts responsibly will now try to invest larger sums safely. Nouriel Roubini, Professor at the Stern School of Business in New York
The markets initially celebrated the modest rate hike of a quarter percentage point, but then reacted more sceptically. Former US Treasury Secretary Larry Summers praised Powell: “It is right to emphasize the great uncertainty that the banking crisis brings with it,” he told CNN. However, he added: “Personally, I probably would have given inflation concerns a little more room and left open the possibility of several rate hikes.”
After Wednesday’s rate hike, the Fed’s key rate is in a new range of 4.75 to 5.0 percent. At the beginning of 2022, the key interest rate was still close to zero. Compared to previous interest rate decisions, the central bank’s statement was worded more cautiously and no longer hinted at several rate hikes.
Hope for first rate cuts in September
While Powell’s statements made it clear that no cuts are expected this year either, immediately after the press conference markets were anticipating an easing of monetary policy in 2023. The bond market is certain that the Fed will cut interest rates in September.
The futures market indicates an interest rate of around 4.5 percent at the end of the year. According to a calculation by the CME stock exchange in Chicago, traders expect another smaller rate hike or no hike at all.
The economists of major US banks, on the other hand, are forecasting several more rate hikes. Goldman Sachs is still assuming a “peak” with a range of 5.25 to 5.5 percent and expects two more increases in May and June. Citigroup even thinks three more interest rate hikes are possible, but emphasizes that the Fed will remain cautious against the background of the banking crisis.
More: What the Goldman vice president thinks about the banking crisis.