Banks are running scared. Is the Federal Reserve about to make things worse?

Three banks and the financial industry were struck by lightning Save the fourth has highlighted the Federal Reserve’s decision next week on whether to continue raising interest rates.

Just two weeks after Fed Chair Jerome Powell suggested raising rates more than previously forecast in an effort to tame inflation, many analysts do not expect a hike of more than 0.25 percentage points, while some Experts are urging policymakers to hold the line on fear. To further destabilize the banking system.

The controversy highlights the multiple and conflicting issues facing the Fed. With key sectors of the economy strengthening and inflation More than double With the Fed’s target rate at 2 percent, the central bank is acutely aware that any sign of its fight against inflation could trigger another wave of rate hikes.

At the same time, raising the federal funds rate now could trigger the kind of distress among other lenders that forced panicked depositors to pull their money out of Silicon Valley banks.

“There’s been a financial crash, and we’re going from no landing to a hard landing,” Torsten Sluk, chief economist at private equity firm Apollo Global Management, said in a note this week. That rates will remain steady when Fed officials meet. March 21-22.

Kathy Bostjank, chief economist at Nationwide, also believes the current stress on the nation’s banking system could make Fed officials think twice about raising rates next week.

“Many people, even myself, were surprised that the Fed raised rates. [4.5 percentage] Points and nothing broke in 11 months. It’s finally confirming the view that the Fed can’t raise rates fast enough without something happening,” he told CBS MoneyWatch.

Treasury issue

Although SVB failed in part because of financial mistakes, analysts say rising interest rates contributed to its collapse. Flush with customer deposits during the pandemic, the bank grew rapidly and put most of those funds into long-term Treasury bonds and mortgage securities.

But as the Fed raised rates, SVB’s investment lost value. This caused the bank to face a drop in deposits as customers worried about possible SVB losses rushed to withdraw their money. The concern now is that this pattern may repeat itself in other banks that are unwilling to hike rates further.

“We’re also seeing fears of balance sheet issues in regional banks,” Bostjancic said. “There is certainly evidence that banks, as they’ve had this huge influx of deposits, have moved a significant amount into Treasury securities. There are other banks that are experiencing this problem.”

Already, some customers at smaller and regional banks are moving their funds to larger institutions, Financial Times correspondent Stephen Gendel told CBS News.

Did the Fed screw this up?

First of all, what is the reason for the rapid growth in SVB reserves? More Americans were flush with cash in the early years of the pandemic, while the tech industry saw explosive growth. According to economists, both factors were bolstered by the government’s response to the Covid-19 crisis: keeping consumers and businesses down with cash, while keeping interest rates at zero for several months after the initial crisis passed in 2020.

The danger now is that the Fed, having been so tight on gas in recent years to propel the economy, is now putting on the brakes and risking a crash.

“Like poor fools, the US Federal Reserve overreacted to cold spells of inflation during the Covid crisis by easing monetary conditions for far too long,” said Will Denyer of Geocl Research in a note this week. wrote “The danger now is that the Fed has cranked the handle too far the other way … tightened conditions so much that it has started a disinflationary process that will spiral downward, possibly into recession. will cause the market.”

Financial conditions are tight

The Fed’s primary means of controlling inflation is to use overnight lending rates to slow the economy. But many economists say inflation is now cooling sufficiently on its own without the need for additional support from the Fed, especially given the lag between monetary policy and economic growth. The current turmoil in banking and financial markets will make lenders far more cautious, adding to inflationary pressures.

“Going forward banks, particularly small and medium-sized banks, are likely to significantly tighten their credit standards,” Nationwide’s Bostjanic predicted. “Fed officials need to consider that more cautious bank lending will be an additional drag on economic activity, and that could be significant.”

Conversely, the Fed may very well decide that it has done enough to improve the banking system and continue to raise interest rates after the collapse of SVB and New York’s Signature Bank. After these failures, the Fed created a new lending program that effectively insured other banks’ treasury holdings against losses for up to a year. The central bank may choose to maintain the rate hike course as a sign of confidence in its policy measures and its continued commitment to reducing inflation.

“Does the decision send a message that they are still wary of inflation and confident in the stability of the banking system? Which message conveys stability and confidence?” asked Ed Mills, a Washington analyst at Raymond James. “I think the Fed has another week to digest it.”

“The banking industry operates on trust as much as it operates on capital, and the banking industry is very well capitalized right now,” Mills added. “But there is a real question about trust.”