Inflation, interest rates and bank failures: the US dilemma to drive away the dark clouds of the economy

Inflation in the US has eased slightly, as announced this Wednesday, and these new data in the current context of the banking crisis and the fear of general contagion, highlights the Federal Reserve’s next decision on interest rates, a central factor in the failures of Silicon Valley Bank and Signature, which shook the financial system.

New inflation data could make the Federal Reserve’s interest rate policy, which it is expected to adopt at a board meeting next week, be more flexible: Price hikes have shown signs of being persistent, which would generally require higher rates, but now the new reality of the banking system is pushing prudence.

The Bureau of Labor Statistics reported that prices were up 6% in February from a year earlier. That’s down markedly from June’s peak of 9.1%, but is a moderate decline from January’s 6.4% year-over-year increase. Prices increased by 0.4% in February compared to the previous month.

The new reading suggests that inflation still high by Fed standards (2% a year) and it is still a major threat to homes, businesses and the economy at large. Higher housing costs have weighed heavily in recent numbers, contributing more than 70 percent of the month-to-month increase.

Prices

Food, recreation, and home furnishings have also risen in price, although the price of gas and other energy costs have declined.

Wall Street applauded the steady, if modest, decline in inflation. All three major stock indexes were trading higher on Tuesday, after taking heavy losses on Monday and then recovering. The stock market is seduced by the prospect of an early end to the Fed’s monetary adjustment. The Dow Jones thus gained 1.06%, the technology Nasdaq 2.14% and the S&P 500 index 1.68 %.

In addition to the price news, markets are starting to process the quick actions US authorities took after the collapse of the banks and President Joe Biden’s speech which guaranteed deposits to all customers and ensured the soundness of the US banking system.

However, The dark clouds over the contagion effect have not dissipated and comparisons with the 2008 crisis.

In these days there will be a strong tussle in the Federal Reserve. For a year after the rate was at 0 during the pandemic, the Fed waged an aggressive fight to curb inflation, raising rates at the fastest pace in decades, climbing as high as 0.75 percentage point at a time for several months. .

With prices falling, it fell 0.5 points in December and the latest increase in February was smaller, 0.25 points. bringing the rate to 4.6%, always looking for the balance between containing inflation without chilling the economy or the job market too much.

Since Fed leader Jerome Powell had said in recent days that the economy had cooled “only partially”, many economists estimated that the fight against inflation would intensify this month and would rise by another half point. But now the situation has changed.

what’s coming

The Fed’s efforts have become even more complicated in recent days following the collapse of the banks. In emergency meetings this weekend, the Fed and other regulators took sweeping steps to shore up deposits at those banks, but it’s unclear whether that will be enough to stave off a broader crisis.

Many economists now expect the Fed slow down rate hikesor stop them altogether, when you meet next week.

The collapse of Silicon Valley Bank is, in some ways, a byproduct of the Fed’s aggressive efforts to raise borrowing costs after years of near-zero interest rates.

For years, start-ups and technology companies, the SVB’s main clients, have benefited from a low-interest-rate environment that has enabled access to cheap money. But as the Fed has rapidly increased borrowing costs, those companies were among the first to take a hit.

consulted by clarionSteven Kyle, a professor of economics at Cornell University and an expert on US macroeconomic policy, said that “the big problem for the Fed is that, until now, it seems to have completely ignored the possibility that its aggressive efforts to slow the economy could have systemic consequences. Now that we’ve had two of the biggest bank failures in history in quick succession, they will be forced to take this into account in their decisions.”

He explained that “because further interest rate hikes can cause problems for more banks, they will be more careful in the coming months, as they are still not satisfied with the level of inflation because, although today’s numbers were encouraging, 6% is still well above the Fed’s 2% target.”

For the expert, “the Fed wants to prevent the situation from worsening. They have already shown their unlimited power in these areas by stabilizing the situation as fast as possible. Significantly, however, the Fed had to buy out SVB directly instead of having it bought by another larger bank, as they tend to prefer. This means that other banks did not want SVB’s credit portfolio in their portfolio, even at unfavorable prices, which speaks to the lack of diversification and the risk of decisions that got them into trouble.

“The Fed will be forced to at least slow its rate hikes. Many of us (including me) want a break until we give current rates time to kick in, but I’m guessing the Fed won’t completely abandon its current rate hike policy. This means we may continue to see increases, but most likely only by a quarter of a point (0.25) at a time.”

Beyond the Fed, the expert adds a political component to the situation: “It is also worth noting that deregulation under the Trump administration is also partly responsible for this: if medium-sized banks had continued to be held same stringent standards as the big banks, there would almost certainly have been more warnings about these issues e they could very well have been avoided altogether.

PB extension