The past week’s events saw not one but two banks closed, sending shockwaves from Wall Street to Sand Hill Road and even to Main Street. Of course, it’s never a good thing when banks close, especially not when one of them was America’s 16th largest. The silver lining is that Jerome Powell may finally give up on Fed rate hikes.
Why would the Federal Reserve chair do so after being so hawkish just last week before the Silicon Valley mess?
“The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,” Reuters reported Powell said in prepared remarks for a hearing before the Senate Banking Committee.
I’ve felt that rate hikes, especially at the pace the Fed has been doling them out, weren’t healthy for the average American taxpayer. Unfortunately, it wasn’t very beneficial for a not-so-ordinary bank.
If Jerome Powell doesn’t want to go down in history as the worst Federal Reserve Chair ever, he’ll, at the very least, pause the rate hikes. A 50 basis-point increase at the next Fed meeting on March 21-22 would be cruel and unusual punishment.
Here are three reasons.
The Bank Failures Could Slow the Economy
This is not something that you want to try every day of the week. However, the distress banks face from so many interest rate hikes over the past year has acted like a slap across Jerome Powell’s face. It’s a wake-up call for sure.
Axios reported on what’s next for the Fed on March 13.
“What’s happening could lead to banks suddenly starting to contract credit supply. But that might happen too fast for the Fed’s liking,” Jan Groen, TD Securities’ chief U.S. macro strategist told Axios.
“Despite the fact that they are behind in the fight against inflation, the Fed has also made it clear that they would like not to disrupt the economy too much right — they’re looking for [a] soft landing. This is the uncertainty that they’re now confronted with, basically overnight.”
Unfortunately, because the Fed has gone into its quiet period, they’re unable to shed any light on their thoughts on the subject. We’ll find out in a week.
Ongoing Rate Hikes Will Pancake the Economy
First Republic Bank (NYSE:FRC) saw its stock drop 62% on March 13. JPMorgan Chase (NYSE:JPM) was a “lucky” bank stock. It barely was in negative territory for the day, down 1.8%. However, the SPDR S&P Regional Banking ETF (NYSEARCA:KRE) was down more than 12% as investors bailed on these smaller banks.
Even though the Fed and the Treasury Department are providing liquidity to banks like First Republic — it has $70 billion in new liquidity available because of this move—shareholders of these banks don’t want to be left holding worthless stock certificates should more losses surface. Better to act now, sell your holdings, and buy back in should the “all clear” signal sound.
However, whatever fears investors have now will ratchet up exponentially should Powell keep raising rates.
CNN Business discussed Sheila Bair’s thoughts about Fed rate hikes after Silicon Valley’s implosion. Bair is the former Federal Deposit Insurance Corporation (FDIC) chair. The FDIC is the receiver of SVB. So it’s the federal agency making all of the bank’s customers’ deposits whole.
“The Fed needs to hit pause and assess the full impact of its actions so far before raising short rates further,” Bair told CNN Business in a March 12 phone interview.
A 50 basis-point hike would send the markets and the economy into a death spiral.
America’s Been Hurt More By Higher Interest Rates Than Inflation
Economic theory, as it relates to inflation, states that when you want to cool it, you raise interest rates, which slows business borrowing and consumer spending, ultimately reducing demand and lowering prices.
Former U.S. Secretary of Labor Robert Reich stated in a March 8 op-ed for The Guardian:
“Relying on further interest-rate hikes to fight inflation will only worsen the consequence of America’s near-record inequality. The people who will endure the biggest sacrifices as the economy slows will be the first to lose their jobs: mostly, those in the bottom fifth [of income earners].”
“There’s no reason for further hikes, anyway. Inflation is already slowing.”
These comments were before the Silicon Valley Bank implosion. I don’t imagine Professor Reich’s opinion changed in the week since. In fact, I bet it’s hardened.
What drives me nuts is the focus on inflation. I know we don’t want to end up with persistent inflation for decades.
However, Motley Fool research expert Jack Caporal’s November deep dive into the average American households’ average monthly expenses in 2021 tells me that food prices are a bit of a red herring.
According to Caporal, the average monthly spending on housing was $1,885, 34% higher than a year earlier. It accounted for 34% of the $5,577 average monthly expenses per household. Food was $691, 12% higher than a year earlier, accounting for 12% overall.
When Jack does his 2022 analysis in November, we will see that these categories experienced big increases. Moreover, he’ll probably reveal that every category increased in 2022, providing the Fed with a built-in excuse for raising interest rates.
However, it’s a lot easier to cut back on entertainment, apparel, and even food spending to a lesser extent, but somewhere to live is kind of important. And it’s by far the biggest expense.
Nearly 66% of American households own a home. Approximately 63% of those households have a mortgage. So, about 55% of American households have a mortgage. The past year has been tough on those homeowners, especially anyone who’s had to refinance a mortgage.
My guess is that Jerome Powell doesn’t have a mortgage on his house or condo — just a hunch.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.