“The Impact of the Federal Reserve’s Rate Hike on the US Economy: Banking Turmoil, Inflationary Pressures, and the Possibility of a Recession.”

Interest rates in the US are over 5%. Confirming market expectations, the Federal Reserve increased the cost of money by 0.25%. This is the tenth consecutive increase, which brought the Feds funds, i.e. the reference rates, to the range of 5-5.25%, the highest level since mid-2007.

It could be the latest intervention by the US central bank. “The support for the new adjustment has been very strong, we are getting close, but maybe we are there,” said Fed Chairman Jerome Powell in the usual press conference after the announcement of the monetary policy decisions. But it will be “a continuous evaluation, meeting by meeting,” he insists. Why the Fomc, the Fed’s monetary policy committee “decided on an increase, but did not discuss a break”, precise. Emphasizing, however, the “significant change” in the guidancei.e. the guidelines of the central bank’s action. The Fed removed the sentence from its earlier statement that it might need “some more” rate hikes. He replaced it with the statement that he will consider a number of factors to “determine the extent” to which “future hikes” might be appropriate. From now on, therefore, in order to bring inflation back to the 2% target, «the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation and economic developments and financial”.

At the end of the year, Powell sees the consumer price index at 3% (at the end of March it was 5% from the peak of 9.1% last June). But “we will bring inflation to the 2% target over time,” he says. Fortunately, we can do it without penalizing the labor market », he adds. “This time it’s different,” he underlines, the numbers prove it: the Fed raised rates to 5% and the unemployment rate remains at 3.5%. Therefore it is “possible to cool the labor market without a fall”. And for this “a recession is more likely to be avoided than to have one.” It is Powell’s personal opinion, while economists of the Fed estimate “a mild recession”.

But Fed rate hikes that began in March 2022 have more than doubled mortgage rates, increased the costs of auto loans, credit cards and business loans. And caused the decline in home sales. The latest Fed intervention could further increase funding costs.

The hike in rates, the most aggressive in the last 40 years, also contributed to the collapse of three major banks in less than two months: in mid-March Silicon Valley Bank and Signature Bank, then last weekend First Republic, sold with a flash auction to JpMorgan. All three failed banks had bought long-term bonds, which paid low rates and quickly lost value as the Fed raised rates. «There was the resolution of the three banks at the heart of the crisis, all customer deposits were protected. Now we have to focus on what happens to the availability of credit».

The recent turmoil has already caused banks to cut back on lending. And in the future, credit could decrease further in the face of the need of institutions to increase liquidity, also in view of the strengthening of the supervisory rules. This could act as the equivalent of a quarter-point rate hike in slowing the economy, Powell explained in March. That is why “in light of these uncertain headwinds, added to the monetary policy restrictions that we have put in place”, future Fed actions “will depend on how events unfold”, claims the lawyer-banker. And he repeats: «Meeting for meeting».

But recent bank crashes, in addition to highlighting the need to tighten rules and tighten controls, as revealed by the investigation into the SVB crash conducted by Fed vice president for banking oversight, Michael Barr, have also taught another lesson: how quickly customers withdrew deposits in the so-called bank run. A speed «never seen before, we now know that it is possible and we will have to take this into account,” says Powell. Which also leans on fiscal policy when warns against the prospect of a state default, which could happen as early as June, according to Treasury Secretary Janet Yellen’s warning. “No one should think that the Fed can protect against the damage such an event could inflict on the United States,” she says. But that’s another story.

It is this enormous uncertainty, amidst inflationary pressures, fears of recession and banking turmoil, which is pushing the market to bet on a pause in Fed action and an end to rate hikes. A still premature turning point in the euro area.