Tuesday, March 7 Federal Reserve Chairman Jerome Powell testified in front of the Senate Banking Committee. His message was hawkish as the Fed Chair discussed not only the persistence of inflation (and the committee’s plan to continue raising interest rates), but also opened the door for a larger increase (0.50%) at the next meeting. He reiterated his stance that rates will likely remain at a restrictive level for a prolonged period. While the Fed acknowledged the economy has slowed, policymakers believe it is a long way from recession based on the labor market data. 

Despite the Fed’s efforts to slow the economy, labor markets remain extremely tight and inflationary. The most recent employment report showed solid growth as the U.S. economy added 311,000 nonfarm payrolls in February. The 3.6% unemployment rate is hovering near 50-year lows. However, wage gains and average hourly earnings have moderated, a small and encouraging sign wage inflation may be declining. The Fed continues to believe softening in the labor market is necessary to bring down inflation.  

As the headline level of inflation remains well above the Fed’s 2% target, the rate of change has been falling. The year-over-year Consumer Price Index (CPI) peaked at 9.1% in June 2022, and has declined sequentially over the past eight months. The most current CPI year-over-year reading was 6% in February. Disinflation has occurred within the goods sector of the economy, and flattening rents are expected to cool housing inflation. However, there are little signs of disinflation from the larger services sector, which includes travel and leisure and represents more than half of the CPI index. Services sectors are less sensitive to interest rates and influenced more by labor and wage costs.   

Over the past year, the central bank has raised its benchmark interest rate eight times, taking the Federal Funds Rate to a range of 4.50-4.75%. While the Fed has acknowledged that monetary policy moves have lagged impacts, they have also indicated nothing in the data suggest they have tightened too much, but that was prior to Silicon Valley Bank’s (SVB) announcement. 

For decades, Silicon Valley Bank, a highly respected financial institution, played an integral part in the venture capital and start-up technology and life science community. As a result of the Fed’s aggressive tightening campaign and to further improve its balance sheet and liquidity position, SVB announced the sale of its government bonds and a plan to raise additional capital from the private and public markets. Market participants responded irrationally, including venture capital firms who instructed their portfolio companies to withdraw SVB deposits. This sparked a panic which led to a classic run on the bank’s deposit base. Working together, the Federal Reserve, Treasury and FDIC shut down SVB, designated the bank as systemic and devised a plan to backstop both insured and uninsured deposits. Shortly after, regulators implemented similar policies and procedures at Signature Bank of New York, which had been a popular funding source for cryptocurrency companies.   

The next Fed meeting is March 21-22. Until now the capital markets have not seen the full effects of rate hikes. While the Fed is committed to restoring price stability and staying the course until the job is done, the hawkish inflation rhetoric has changed to stabilizing the banking system. The ongoing developments of the last week are inherently disinflationary and will have a tightening effect on the economy regardless of the Fed’s policy decision next week.  


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