On Wednesday, Federal Reserve officials announced a 0.25% increase in the target federal funds rate as a sign of caution given recent tumult in the banking sector. The move continued a slowdown in rate hikes meant to combat inflation.
The current target interest rates stand between 4.75% and 5.0%, having been set between 0.0% and 0.25% during the lockdown-induced recession last year to stimulate economic activity. Recent indicators point to modest growth in spending and production with job gains running at a robust pace and low unemployment rate; however, inflation remains elevated at 6.0%.
The past four rate hikes by the Federal Reserve amounted to a total of 0.75%, followed by a 0.5% hike in December 2022, as inflation had risen as high as 9.1% in June 2022.
This week’s decision was made more complex by the implosion of Silicon Valley Bank and Signature Bank earlier this month, along with broader global financial volatility, forcing Silicon Valley Bank to sell its long-term bond portfolio at a loss due to higher interest rates amid bank runs from customers with more than $250,000 insured by the FDIC but secured through government insurance for all accounts across banks
On Wednesday, the Federal Open Market Committee shared that current developments could lead to tightening of credit conditions for households and businesses, potentially slowing down economic activity, hiring, and inflation. The degree of impact remains unknown at this time.
A research report from National Bureau of Economic Research observed a 10% decrease in bank assets due to restrictive policy set by the Federal Reserve and believed that this could have resulted in more than $2 trillion being wiped off the book value. It further highlighted that banks are now highly vulnerable to runs from uninsured depositors given the drop in long-term holdings.
Prior to this instability within financial markets, Jerome Powell mentioned that there was strong evidence of labor market stability and inflation remaining steady – a point which convinced Fed officials to increase target interest rates despite household wages declining over two years when adjusted for inflation.