Fed Eases Tone On Rate Hikes As Aftershocks From Bank Failures Spell Credit Tightening

The Federal Reserve has slightly backpedaled from its course of more aggressive rate hikes after the unexpected collapse of several financial institutions raised broader concerns that banks could tighten lending in the coming months.
The Federal Open Markets Committee (FOMC)—the central bank’s policy panel—held onto its inflation-combating campaign by raising the federal funds rate by one-quarter of a percentage point on March 22, but in a news briefing, Fed Chair Jerome Powell said policymakers will “no longer state that we anticipate that ongoing rate increases will be appropriate to quell inflation.”
Rather, he added, “we now anticipate that some additional policy firming may be appropriate.”
Why The Fed Altered Its Rate-Hike Stance
The shift in the Fed’s wording largely stems from the unexpected collapse of Silicon Valley Bank and Signature Bank barely two weeks ago, as well as the pending fire sale of Credit Suisse to UBS.
Until this mini bank crisis, many observers were predicting the Fed might ramp up its rate increases, since the current inflation rate of 6.04% is nowhere near the Fed’s long-term target of 2%. Now, however, the Fed and economists have expressed concern that if the aftershocks of the bank failures cause more lenders to clamp down on credit flows—enough to hurt the economy—the Fed may need to ease up on its rate hikes or even consider rate cuts down the road.
“Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes,” Powell said at the news briefing on March 22. “It is too soon to determine the extent of these effects and therefore too soon to tell how monetary policy should respond.”
Powell on the Mini Banking Crisis: ‘How Did This Happen?’
Up until two weeks ago, Powell held strong to the Fed’s rate-raising agenda. He told Congress at hearings on March 7 and 8 that economic data suggests “the ultimate level of interest rates is likely to be higher than previously anticipated.”
But in the days following those hearings, Silvergate Capital, Silicon Valley Bank (SVB) and Signature failed suddenly, forcing the government to step in on Sunday, March 12 with an emergency rescue plan. The Fed and other government leaders have reiterated that these banks were not traditional banks—they dabbled in riskier businesses like crypto markets, tech startups and investments sensitive to Fed rate hikes (specifically in SVB’s case).
But shock about SVB’s struggles spread rapidly on social media, motivating its depositors to remove cash in droves. Never before had a bank run been driven by social media platforms. Deposits were withdrawn so quickly and unexpectedly that it forced the government to take over SVB before regulators could fully assess the situation. The government rushed in, creating a new emergency loan program so most of the bank’s otherwise uninsured deposits would now be covered.
“The question we were all asking ourselves over that first weekend was, ‘How did this happen?’” Powell said.
While Powell reiterated that the latest failures were anomalies and “not weaknesses that are, at all, broadly through the banking system,” he acknowledged there were lessons to be learned by banks and their regulators.
“SVB experienced an unprecedented rapid and massive bank run…faster than historical record would suggest,” he said. “It’s clear we do need to strengthen supervision and regulation.”
Economists Debate Whether More Rate Hikes Will Help the Economy or Trigger Recession
Reactions among economists were mixed. Some had expected the Fed to pause rate hikes this time or, more likely, in May. Others read the Fed’s decision to continue with rate hikes as a sign the Fed will keep its focus on inflation.
“Some investors believed that the recent weakness for a number of regional banks would be enough to cause the Fed to pause in their rate hiking cycle at this meeting, however the hike serves as a signal that the Fed remains committed to combating inflation,” wrote Sam Millette, a fixed income strategist at Commonwealth Financial Network, in an analyst note.
There’s also growing concern that if the Fed continues raising rates amid more severe credit tightening in the banking system, the increases will trigger a recession.
“Teetering confidence in the banking sector, even if currently contained to a small number of banks, offered the Federal Reserve a perfect opportunity to pause without signaling that it was throwing in the towel on inflation,” wrote Marty Green, principal at Polunsky Beitel Green. “Instead, the Federal Reserve appears to be continuing to dance to last month’s music, not fully aware that the tune is vastly different today.”
The FOMC meets again in early May. In the meantime, Congress will be questioning regulators on the recent bank failures, starting with a hearing by the House Financial Services Committee scheduled on March 28.