This week in Bidenomics: Busted banks to the rescue!
If you notice a sly grin on President Biden’s face, it might reflect hope that the solution for high inflation has finally arrived.
Inflation has been Biden’s biggest domestic problem for more than a year, and the Federal Reserve hasn’t yet forced prices down enough to declare victory. But a new and unexpected force may help the Fed get the job done: The recent failure of two banks and the sudden concern about financial-sector stability.
The failure of Silicon Valley Bank and Signature Bank has brought urgent attention to the stress some mid-sized banks are facing from rapidly rising interest rates. Both banks got caught selling assets at a loss when they needed to cover customer withdrawals, because securities they bought at low interest rates a couple of years ago are now worth less, on account of surging rates. Regulators took over both banks, while a third, First Republic, needed an infusion of capital from other big lenders to avoid a similar failure.
Uncertainty abounds, as investors and regulators hold their breath and hope the risk of contagion abates. It’s still possible a bigger banking crisis could torpedo the whole economy. But there’s also a chance that tighter financial conditions caused by newly skittish lenders will directly help the Fed in its effort to cool the economy and subdue inflation, with a sense of normalcy returning by late this year or early next.
Economic data is jumpier than usual, given the dramatic risk a financial crisis can pose to the broader economy. But inflation data suddenly looks a bit more encouraging. Since Silicon Valley Bank first indicated trouble on March 8, expected inflation, as indicated by bond rates, dropped from 2.47% to 2.26%. That might not sound like a lot, but it’s a meaningful change for such a short period of time.
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Investors have sharply altered their expectation for Federal Reserve action at its next policy meeting on March 22 and 23. Before the SVB failure, the market believed there was an 80% likelihood the Fed would raise rates by half a percentage point, according to CME Group. Just 10 days later, that likelihood has fallen to essentially 0. The market still thinks the Fed will raise by a quarter point, but there’s about a 15% chance of no rate hike at all.
The logic is a bit circular. The Fed may ease off rate hikes because it doesn’t want to add any further stress to banks already hurting from the rapid rise in rates. That might simply mean the Fed tolerates high inflation as a lesser evil than a financial crisis. Or, it could imply the Fed may think it can ease off because the bank crisis itself will tighten financial conditions, rein in credit and help bring down inflation.
The Fed has hiked rates by 4.5 percentage points since last March, one of the fastest tightening cycles on record. Inflation has fallen from a peak of 9.1% to 6% in February. But the improvement isn’t fast enough and there have been signs recently that inflation could actually intensify. The Fed slowed its pace of hiking in December, but Fed Chair Jerome Powell has consistently said the job isn’t done and more rate hikes are likely.
The Fed may now want to take a breather while it assesses how the banking stress will affect the broader economy. “The turmoil will likely lead to a tightening in underwriting standards and less credit availability,” economist Matt Colyar of Moody’s Analytics wrote on March 16. “We assume that the Fed will pause its rate hikes in March to gauge just how much conditions have tightened.” If there’s no further upheaval, Moody’s Analytics thinks the Fed could raise rates by a quarter point in both May and June, possibly stopping there.
Economists remain split on whether a recession is coming. Fed critics such as Democratic Sen. Elizabeth Warren of Massachusetts are already bashing the Fed for raising rates too quickly and threatening jobs, even though employment has remained strong. Many of those same critics now say the Fed and other regulators failed to stop the kind of banking crisis they’re supposed to prevent.
Biden has vowed to stay mum on Fed policy, in contrast to his predecessor, President Donald Trump, who publicly pressured the Fed to pursue easy-money policies that might goose the economy. In remarks on the bank rescues, Biden didn’t mention the Fed or inflation. He did assure Americans that “the banking system is safe” and that the government will protect everybody’s deposits. Americans are supposed to be able to take that for granted. Maybe while thinking about that, they’ll forget about inflation for a moment or two.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman
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