The Washington Post

Fears of a lead-footed Fed follow bank panic

As stocks recover, worry grows about aggressive interest rate hikes


Days of panic over a potential banking crisis gave way to a tenuous calm Tuesday, as bank stocks rebounded sharply on hopes that new backstops for the financial system would be enough to stem a broader meltdown.

Still, the road ahead remains shaky. Concerns over an increasing­ly fragile financial system after two bank failures are complicati­ng the Federal Reserve’s already rocky path to slowing the economy.

The central bank is now weighing stubborn inflation readings — including new data released Tuesday — against jittery global capital markets in deciding how much higher interest rates can go when it meets next week.

The Justice Department and Securities and Exchange Commission are investigat­ing Silicon Valley Bank’s collapse and the actions of its senior executives. And Moody’s on Tuesday downgraded its outlook on the entire U.S. banking system from “stable” to “negative,” citing a “rapid deteriorat­ion in the operating environmen­t.”

“There’s new optimism that we won’t have a full-blown crisis, but we can’t just go back to sleep like nothing happened,” said Itamar Drechsler, a finance professor at the University of Pennsylvan­ia’s Wharton School. “Even though things aren’t irreparabl­y broken, that doesn’t mean there aren’t more challenges ahead.”

The sudden and spectacula­r collapse of Silicon Valley Bank last week set off tremors of cascading runs at other U.S. banks after depositors withdrew a record $42 billion in just 24 hours from the California institutio­n.

In an emergency move over the weekend, federal regulators took sweeping steps to prop up deposits at SVB and Signature Bank of New York, another failed institutio­n. But that wasn’t enough to immediatel­y assuage investors’ fears: Shares of regional bank stocks plummeted by as much as 62 percent Monday.

By Tuesday, though, the mood had improved. All three major stock indexes rebounded, as bank shares made up for much of their losses from the day before. Even First Republic Bank, a midsize San Francisco bank that lost twothirds of its stock value earlier in the week, managed to make up some of those losses. Its shares, which fell from $82 to $31 between Friday and Monday, were up to about $40 at Tuesday’s close.

“Initially the fear was that the SVB collapse, followed by a second bank failure on Sunday, would roll into something even bigger and more devastatin­g,” said Pao-lin Tien, an economics professor at George Washington University. “The good news is that we haven’t seen any further bank failures. The fact that things are calming down means we are managing the crisis well at this initial stage. Our policies are working.”

That newfound optimism, combined with new inflation figures released Tuesday, reignited debate over just how much higher the Fed might lift interest rates when it meets next week. The central bank has been rapidly raising borrowing costs for a year in hopes of slowing the economy enough to temper fast-rising prices. But now the bank failures, partly sparked by investment­s that went south as interest rates rose, have ratcheted up worries that the Fed has moved too fast.

Although inflation has eased from June highs of 9.1 percent, it remains too high for comfort. Prices rose 6 percent in February compared with a year earlier, according to new data released Tuesday by the Bureau of Labor Statistics.

Higher housing costs weighed heavily on the latest figures, contributi­ng to more than 70 percent of the monthly increase. Food, recreation and household furnishing­s also rose in price, though natural gas prices and other energy costs fell.

“Big picture, progress on taming inflation has been slower than we had imagined,” said Pooja Sriram, an economist at Barclays. But, she added, “for the Federal Reserve, risk management considerat­ions are likely to take priority, at least for now.”

Banking experts said regulators’ recent effort to protect all deposits at SVB and Signature Bank, even those over the $250,000 limit for federal bank guarantees, raises broader questions about whether those protection­s would be extended to all uninsured deposits if other banks were to fail.

“Down the road the important job is to figure out what policy changes we can make to ensure we don’t end up encouragin­g banking institutio­ns and depositors to take on unnecessar­y risks,” said Tien of George Washington University.

By many measures, the U.S. economy remains extraordin­arily strong. Employment is high, workers are getting raises and people are continuing to spend briskly despite high inflation. But in recent months, there have also been troubling signs, including rising credit card balances and high-profile tech layoffs, that have led to growing fears that the country could tip into recession later this year.

The latest round of financial tumult intensifie­d those concerns, even as policymake­rs sought to reassure Americans that their money was safe. President Biden doubled down on that message Tuesday, calling the recent bank failures a small blip in the United States’ path to a more solid economy.

“As I’ve long said, and as challenges in the banking sector remind us, there will be setbacks along the way in our transition to steady and stable growth,” Biden said in a statement. “But we face these challenges from a position of strength.”

There are already signs that the Fed’s tightening is working, at least in some parts of the economy.

The housing market has slowed, manufactur­ing is down and prices on a number of goods have stabilized. Washing machines, tires, smartphone­s, meat and whiskey all got cheaper in February, though economists say there is still a long way to go in bringing down “sticky” prices on services, such as rent, transporta­tion and restaurant­s.

Housing prices have had a particular­ly outsize impact on inflation in recent months, in part because of how shelter costs are calculated in the U.S. consumer price index. There is often a lag of nine to 12 months before changes in rent prices show up in inflation data.

“We saw a tick back up in housing, but a lot of that is for methodolog­ical reasons,” said Andrew Patterson, senior internatio­nal economist at Vanguard, referring to federal calculatio­ns that involve rental projection­s and not actual sales prices. “We believe housing is going to start to be a drag on inflation in the second half of the year, which should help the Fed.”

Still, he said, the latest report “further signals that the Fed has more work left to do.”

Moving at remarkable speed, the Fed has hiked its base policy rate from near zero to between 4.5 percent and 4.75 percent. Although analysts had previously expected the Fed to keep hiking rates until they settled between 5.5 percent and 6 percent, some are scrapping those projection­s to account for an immediate pause after the bank failures.

The collapse of Silicon Valley Bank is, in some ways, a byproduct of the aggressive efforts to raise borrowing costs after years of near-zero interest rates. For years, start-ups and tech firms benefited from easy access to cheap money. But as the Fed has rapidly raised borrowing costs, those firms have been among the first to take a hit.

Now Goldman Sachs this week said it no longer expects the Fed to raise interest rates at all in March “in light of recent stress in the banking system.” The bank’s economists say the central bank is likely to pick back up with quarter-point rate hikes in May, June and July, though they note there is “considerab­le uncertaint­y” ahead.

Others, though, including Bank of America and Citigroup, are still forecastin­g a quarter-point interest rate increase, a step down from what many expected just last week, after Fed Chair Jerome H. Powell told Congress the central bank wouldn’t hesitate to raise rates faster than planned if the economy didn’t appear to be slowing rapidly enough.

That extra uncertaint­y is making some business owners nervous. Rami Tannous, who owns Hidden Hype Boutique, a men’s streetwear and sneaker store in San Jose, says shoppers have been pulling back for over a year. Higher rent and gas prices mean many are trading down to lower-priced goods or buying one pair of shoes instead of two.

Now, with the failure of nearby Silicon Valley Bank, he’s bracing for another round of cutbacks.

“There was a real panic over the weekend, but even with the [federal] guarantee of funds, I think people are still freaked out,” he said. “Uncertaint­y is a big problem for us.”

 ?? Dustin CHAMBERS/BLOOMBERG News ?? Shoppers at an Atlanta flower shop on Valentine’s Day. A government report shows prices last month were 6 percent higher year over year. That data may clash with jitters over the weekend bank panic as the Federal Reserve weighs a possible interest rate hike next week.
Dustin CHAMBERS/BLOOMBERG News Shoppers at an Atlanta flower shop on Valentine’s Day. A government report shows prices last month were 6 percent higher year over year. That data may clash with jitters over the weekend bank panic as the Federal Reserve weighs a possible interest rate hike next week.
 ?? source: Bureau of Labor statistics the washington Post ??
source: Bureau of Labor statistics the washington Post

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