Another failed bank, another rate hike
The second largest bank failure in history did little to deter the Fed from yet another rate hike at today’s FOMC meeting. The move pushed the Fed funds rate to a new all-time high of 5.25%. In a busy week for government officials, regulators seized First Republic Bank late in the week, followed by a swift weekend bid process before awarding the bank to its preferred private banking partner, JP Morgan on Monday. For the headline of “second largest bank failure in US history”, the takeover occurred swiftly, calmly and without typical media frenzy. Compared to the SVB and Signature Bank failures in March, this seizure barely rippled the surface of public attention.
With markets accepting First Republic’s fate, Jerome Powell addressed the biggest issue facing our nation’s financial stability, inflation. Stubbornly high core inflation and low unemployment pushed Powell to once-again ratchet up rates another 0.25%. The footnotes of this meeting may prove to be more insightful than the rate move itself. The Fed changed its forward-looking tone this week to “pausing” or possibly reaching the end of rate hikes. They also briefed the media on his newfound concerns for stability in the credit market. The comments come as no surprise given recent bank failures and the looming commercial real estate loan maturities cliff growing more ominous by the day.
The chart below depicts just how far and fast we’ve come since the first rate hike back in March ‘22. It also oddly resembles the hiking path, albeit much steeper, taken by the Fed in it’s last material rate hiking cycle from 2005 - 2008. An interesting difference between then and now is the Central Bank’s balance. Back in 2008 it stood at around $1T versus $8T today. Even more striking is federal debt, which stood at $9T vs $31T today. Debt service as a % of GDP will continue growing, straining government budgets and new treasury issuance in the years to come.
So what comes next? In an almost forgone conclusion, even reiterated by the Fed themselves, it’s nearly certain we experience a recession later this year, followed by an easing of rates thereafter. It’s likely Powell takes us up another 0.25% at the June meeting, although, it feels like we’ve arrived at peak rates. Regional bank stability will be the key development to track. It’s amazing to me how the banking regulators managed through the crisis. Deposit guarantees restored public confidence swiftly despite 2 of the 3 largest bank failures in US history. Will we be so lucky with the next shock?
