Rumors that the failure of Silicon Valley Bank (SVB) would be enough to spook the Federal Reserve out of its relentless campaign to raise interest rates started cropping up before Signature Bank’s implosion came to light only days later. But as the May 3rd Fed meeting inches closer, it’s becoming clearer and clearer that those speculations may be nothing more than wishful thinking.
In the weeks leading up to SVB’s demise, expectations that the benchmark interest rate of the US central bank would increase to as much as 5.7 percent by the summer of 2023 were reflected in futures markets. Then, a monetary domino-effect happened: a bank run tipped SVB into the red on March 10, which prompted many of Signature Bank’s customers to panic and withdraw such large amounts of money that federal regulators had to intervene and shut it down on March 12. The, because tragedy comes in threes, Credit Suisse (a major global bank with operations in many countries, including the United States) collapsed later that month before Swiss authorities hastily brokered a takeover of the bank by larger rival UBS. With two of the largest bank failures in U.S. history and the shotgun merger of a major bank abroad, market analysts believed that the Fed would no longer need to take such drastic measures in order to fulfill its policy objectives.
The series of extraordinary liquidity crises made last month one of the most notable time periods since the financial crisis in 2008, but leading up to the trail of bank failures, the Federal Reserve dominated headlines for cranking interest rates up at a speed not seen since the 1980s. Under normal circumstances, the Fed gravitates towards incremental monetary policy for a number of reasons, like the fact that it allows the central bank to monitor the effects of its policies and make adjustments as needed. But mainly, the Fed avoids large and sudden policy shifts, like repeatedly pushing up interest rates, because it could disrupt the global economy. That said, the Fed regularly monitors economic data, including employment, inflation, and GDP, to assess the state of the economy and determine whether policy adjustments, gradual or not, are necessary to achieve its goals.
Still, the Fed does sometimes react to unexpected events, such as financial crises or external shocks to the economy. In such cases, the Fed may need to take a rapid and decisive approach to stabilize financial markets and prevent a deeper economic downturn. Considering that inflation had shot to a four-decade high, the Fed determined that it could not afford to take its time given the current health of the economy, knowing that doing so carried the risk of spiraling the economy to an even worse state. Despite complaints from the real estate sector that interest rates had crept high enough to hinder dealmaking, broader fundamentals made it look like the Fed’s plan was beginning to work; the economy showed growth in the second half of 2022, and inflation had begun to trickle down. But news of SVB’s collapse cast a shadow over the horizon, signaling that the Fed’s stance may have backfired.
SVB primarily caters to the tech and life sciences industries, which have both boomed in recent years. As such, SVB had amassed a huge stockpile of cash from these customers within the past three years. SVB opted to push that stockpile towards U.S. Treasury and mortgage-backed securities. But SVB bet on assets that were sensitive to rising interest rates. As rates went up, the value of those assets went down. Once customers realized the insolvency risk, they flocked to take their money out, you get the picture.
The Fed quickly jumped into damage control by rolling out an emergency lending program to assure that banks would have enough capital to meet the needs of their depositors, but the Fed’s monetary tightening that stressed the banking sector has spilled over into the commercial real estate industry, with many industry leaders warning that CRE is in a critical stage of risk. Commercial real estate relies on debt, which means that banks hold the main source of funding for the sector. But with every interest rate hike, banks have become increasingly hesitant to lend money for CRE transactions, but current market conditions are making the outlook for CRE even bleaker.
Nearly $450 in CRE debt is slated to mature this year, and over half of the sector’s commercial mortgage debt will need to be renegotiated within the next two years (during the time when lending rates will likely be up 350 to 450 basis points). These conditions are setting the stage for a crash worse than what was experienced in 2008. As Chief Executive Officer of JPMorgan Asset Management George Gatch puts it, “when the Federal Reserve hits the brakes, something goes through the windshield.” If the Fed continues to nudge interest rates any higher, troubles in CRE could very well worsen as lenders, now jittery from the recent string of bank collapses, become even less likely to dole out loans.
With all of this panic brewing, analysts were certain that the Fed would be moved enough to let up on rates. Before the Fed’s March 22nd meeting, Goldman Sachs issued a note to clients that read: “In light of the stress in the banking system, we no longer expect the FOMC [federal open markets committee] to deliver a rate hike at its next meeting.” Alas, the Fed did in fact issue another rate hike, bringing the federal funds rate up 25 basis points.
If there was any sign that the recent bank fallouts would discourage the Fed from their rate hike campaign, the Fed chair himself has dashed it. During a press conference to discuss the March rate hike, Jerome Powell blamed SVB’s failure as an isolated incident that stemmed from a management fumble rather than a direct result of the Fed’s monetary policy. “At a basic level, Silicon Valley Bank management failed badly…They exposed the bank to significant liquidity risk and interest rate risk.”
With the finger pointed at SVB, Powell has shown no signs that the banking crisis has affected the Fed’s strategy. Because whether or not financial institutions are struggling, inflation is perched at 6 percent, way above the 2 percent target that the Fed is eyeing, and interest rate hikes are the Fed’s greatest weapon against inflation. As the May meeting draws near, market analysts should uncross their fingers that the Fed will lay off pushing the “Up” button on the interest rate lever and brace for yet another increase.