WASHINGTON, 23 March 2023:
Financial markets have quickly dismissed the latest interest rates hikes by the US Federal Reserve and instead focused on dovish signals in the de facto American central bank’s dot plot, including a rate cut of 75 basis points next year.
Seeing only the growing liquidity flow, the market interpreted it as the end of the tightening monetary policy cycle, with swap markets betting that the US Fed rate will fall to 4.19% at the end of this year, wrote financial broker Octa FX in a statement.
When the US Fed continued its fight against inflation and once again raised interest rates by 0.25% yesterday, the broker described this move as causing concern because the present banking crisis has developed precisely because of rising interest rates.
So far, the US Fed’s successful strategy for fighting inflation has been to raise the key rate and reduce the balance sheet. This negatively impacted the value of US Treasury bonds and other securities, which are an important source of capital for most US banks.
Silicon Valley Bank was the first to fail – it was forced to quickly sell the cheaper bonds at a significant loss, leading to a liquidity crisis and eventual collapse. This was followed by Signature Bank and Credit Suisse, which had to sell-off, and First Republic, which received a lifeline.
“The US Fed recognised its mistake and took emergency measures to support the banking system. It provided US$303 billion of liquidity to banks through the Discount Window and Bank Term Funding Program, thereby curbing the banking crisis locally.”
The crisis also spread to the eurozone, with Credit Suisse failing after a 166-year run. To prevent a complete collapse, the Swiss National Bank opened a credit line for Credit Suisse, which enabled it to take a US$53.7 billion loan and stay afloat. However, it ultimately failed.
OctaFX financial market analyst Kar Yong Ang wrote: “It is commendable that the US Fed did not cave to market pressure and maintained the course to suppress inflation. This is a crucial step that will help them curb inflation and perhaps even avoid a recession.”
As the banking sector is still seen as facing great risks, the regulators’ fight against inflation could make it more unstable – ultimately dragging the rest of the economy down the chain and potentially causing a global recession. Only time will tell whether this happens.
Meanwhile, the US Fed wrote: “The US banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks.”