Last week the Federal Reserve unsurprisingly announced yet another increase to the federal funds rate, a 25 basis point bump, on the heels of the very recent banking shake up. The federal funds rate increased from 4.75% to 5%. In a string of recent larger rate hikes, the 25 points matched the most recent increase, perhaps a sign that the feds are slowing down.

In its statement, the Federal Open Market Committee offered assurance that the “U.S. banking system is sound and resilient,” but acknowledged the Silicon Valley Bank collapse is likely to lead to a tightening of credit conditions down the economic pipeline, with “uncertain” effect on households, small businesses, hiring, and inflation. Powell noted that banking concerns were not limited to SVB alone. The tightening of lending standards elevates the risk of recession through the slowing of economic growth and resulting decrease in inflation. Notably, the Fed replaced its warning that “ongoing increases will be appropriate” with a gentler “additional policy firming may be appropriate.”

Powell calmed nerves by pointing out that poor management was to blame for the SVB failure, and that the quick federal response demonstrates that the government has “the tools to protect depositors” and is not afraid to use them.

This credit contraction may lead the Fed to stop hiking rates, but what does it mean for the economy to have this bank uncertainty? If the pundits are correct, it’s likely to lead to a credit crunch, which is inherently disinflationary. There are signs of disinflation afoot – the economy is showing less wage pressure on the services side of the economy, and housing data is showing stability, though that may just be a reflection of a brief drop in mortgage rates. In the meantime, the February core CPI hit a five month high and the personal consumption price index (PCE), favored by the Feds, was higher than expected.

The Fed is walking a narrow path between alleviating a banking crisis and combating a continually high inflation rate. Powell acknowledged that inflation creates “significant hardship”, and that “without price stability, the economy does not work for anyone.” If recent moves can still the banking tremors, we may see a pause in rate increases, at least temporarily. Whether careful stepping by the Fed can bring the market forecast of late year cuts to fruition remains to be seen.

We continue to monitor the unfolding issues in the finance sector which may result in some tweaking of portfolios to both try to ease volatility in equity holdings and take advantage of the current higher interest rates by leaning a bit heavier into longer term maturities.

Please be in touch if you would like to discuss this or any other topic.