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Thursday, March 23, 2023
An eventful day for the Federal Reserve left investors with a clear message — our work is nearly done.
Alongside the central bank’s announcement it had raised the target range for its benchmark interest rate by 0.25%, the Fed released updated economic projections that showed its current interest rate hiking cycle has nearly come to an end.
Interest rates now stand in a range of 4.75%-5%. The Fed’s “dot plot,” which outlines interest rate expectations from Fed officials, suggested only one more 0.25% rate hike is likely coming this year.
And that would conclude one of the more consequential periods in Fed history — the consequences of which are just beginning to be fully realized.
At the center of the Fed’s impending pause in rate hikes is a bank crisis that grows out of the Fed’s own actions.
During a press conference on Wednesday, Fed Chair Jerome Powell sought to distance the broader banking system from Silicon Valley Bank, which had been the 16th-largest bank in the U.S. before being taken into receivership on March 10 after suffering tens of billions in deposit outflows.
“At a basic level, Silicon Valley Bank management failed badly,” Powell said. “They grew the bank very quickly. They exposed the bank to significant liquidity risk and interest rate risk.”
Powell added that the bank “experienced an unprecedentedly rapid and massive bank run” due to its “very large group of connected depositors.”
Specific failures. Specific customer dynamics.
And, as Powell acknowledged, a situation likely to face specific investigations regarding this failure.
But the ramifications for the broader economy will not be quite so localized.
In the world of central banking, the impacts never are.
Because whether or not Powell’s comments declaring the “banking system is sound and resilient” become a modern version of Ben Bernanke’s infamous declaration before Congress in 2007 that “we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system,” altering the course of interest rate changes will — and does — have enormous impacts on the economy.
Central bankers and economists often refer to raising or lowering interest rates as a “blunt tool.” And while much is made about the “long and variable lag” of monetary policy, the power of this interest rate tool is not in dispute.
The housing market in the U.S. has been crushed under the weight of higher interest rates.
The tech sector has been punished by rising rates, a dynamic that first meant big tech stocks stopped going up, then more speculative venture projects were funded less enthusiastically, and now the bank that helped fund much of this industry has failed.
Asked Wednesday how the Fed incorporated this month’s baking sector stress into its rate forecasts, Powell said, “What I heard [during the FOMC meeting] was a significant number of people saying they anticipated there would be some tightening of credit conditions, and that would really have the same effect as our policies do.”
In other words, the Fed’s forecast doesn’t call for higher rates because the impacts additional rate hikes might impose on financial markets and the economy are already being felt.
Look at the Fed’s forecasts, and we see a central bank that believes its work raising rates is nearly done.
Look at the banking system, and we see a central bank only beginning to realize what work is yet to come.
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