Home| Technology| About| Customer Support| Leave a Review| Request Demo| Login
Gallery inside!

Fed Rate Increases Are Hitting All At Once

March 19, 2023
minute read

Tighter financing and higher deposit costs are putting pressure on banks — and the economy as a whole.

Everyone understands that interest-rate rises have a temporal lag. It's tempting to compare it to pulling the brake pedal on a car: central banks push the pedal a little, then a little more, and the economy gradually begins to slow down.

This week's banking turbulence demonstrates that this is an incorrect analogy. Monetary policy is more like an elastic band: you may tug on it for a long time and nothing seems to move until the other end suddenly comes pinging straight at you.

This realization will have an impact on what the Federal Reserve does next. But it also emphasizes something else: the seeming choice between caring about inflation and worrying about financial stability is deceptive. Banks continue to be an important avenue for monetary policy transmission to the economy through lending. Bank stability becomes monetary policy at some time. The United States has reached a point when monetary tightening is tearing through the financial system like a slingshot.

So far, Apple’s steps have worked: Its operating expenses during the holiday quarter came in well below the company’s guidance. It’s also expecting growth of those costs to slow considerably in the current period compared with a year earlier. 

But never say never. As of now, it seems unlikely that Apple will do layoffs, but as we’ve seen over the past three years, the world is as unpredictable as ever. Cook himself has said that layoffs at Apple would be a “last resort.” But as an expert in the PR game, he was quick not to entirely rule them out. Money market funds recently had their largest inflows since April 2020, while bank system-wide deposits fell by $54 billion in the week before SVB was shut down.

These expenses disproportionately affect smaller banks, lowering their lending margins. Furthermore, while major banks may have originally won deposits at the expense of tiny banks, greater financing costs will catch up with them as well. The Fed has been reducing its balance sheet, squeezing money out of the banking system; deposits can also be reduced if consumers buy new Treasury notes or invest in money-market funds. Money-market funds have been transferring a large portion of their inflows back to the Fed via its overnight reverse repo facility, which presently contains nearly $2.5 trillion. Total bank deposits have fallen by nearly 3%, or $520 billion, in the last year.

Money has been circulating across the American financial system.

As bank reserve holdings and deposits have declined, money market funds have poured money into the Federal Reserve's RRP.

If depositors seek higher returns and maybe withdraw funds from banks in general as a result of this month's upheaval, the cost of all deposits will climb near the Fed's target rate. Major bank CEOs, including Jamie Dimon of JPMorgan Chase & Co., were already talking about how they were going to have to start raising saver returns at their full-year results in January.

At the same time, market fears have reduced estimates of how hhigh-interestrates will rise. Central banks are now projected to achieve peak rates sooner than previously anticipated. This means that banks will receive less income from their loans and securities holdings in the future. A restriction on interest revenue growth, along with increased funding costs, exacerbates the stress on bank profitability.

This tendency is also present in Europe, but not as swiftly or severely as in the United States. Yet, a reduction in profit projections for banks by investors and experts is one of the reasons why bank share values are declining.

The Stoxx Europe 600 banks index has been down 16% since the end of February, while the KBW US banks index, which includes numerous regional banks, has fallen 24%.

Before this month, rising interest rates boosted bank stock prices.

During six months, the relative price performance of bank stock indexes

Together with decreased loan margins, there will soon be an increase in distressed borrowers to be concerned about. Late payment or default issues have been delayed to emerge in the last year since employment has been strong and many have had a lot of funds left over from the epidemic. It is also evolving.

People are beginning to have problems keeping up with car loans and to a lesser extent credit card bills. Late payment rates on both prime and subprime auto loans that have been packaged up into asset-backed securities are both getting close to their recent peaks in 2016 to 2018, according to analysts at UBS Group AG. These are indicators of problems to come for banks, too. To be sure, banks will likely see loss rates rise back toward normal levels from a very low base rather than a wave of high stress. However, this will still cut risk appetites and tighten credit conditions. 

Other types of loans are also in jeopardy. Commercial real estate values are starting to decrease, and American banks are becoming more vulnerable to that sector than they were previously.

This month's fear factor in finance has two effects. The trigger has been liquidity, which appears to be the key pinch point. But, most cash withdrawn from smaller banks and delivered to major banks or the Fed via money-market funds, for example, may be recycled back to those smaller banks via the Fed's discount window, its new Bank Term Financing Program, or private transactions like First Republic Bank's $30 billion in deposits. The most chilling effect will be on credit conditions, which will limit borrowing just as people and businesses start to run out of all the extra cash they saved during the Covid epidemic.

For a year, the Fed has been gradually tightening financial conditions. It appears like everything is finally occurring – all at once.

Cathy Hills
Associate Editor
Eric Ng
John Liu
Editorial Board
Bryan Curtis
Adan Harris
Managing Editor
Cathy Hills
Associate Editor

Subscribe to our newsletter!

As a leading independent research provider, TradeAlgo keeps you connected from anywhere.

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Related posts.