After yesterday’s decision to raise interest rates by the American Federal Reserve, another banking institution started to tumble.
Yesterday evening, on Wednesday, the American Federal Reserve raised interest rates by a further 0.25%. Currently, rates are at 5-5.25%, the highest they’ve been since 2007. And if the last monetary tightening policy preceded one of the worst recession ever, what awaits us now?
Fears for a banking system collapse are already widespread, following a third major bank failure in a few months. Last weekend, First Republic marked the second biggest bank collapse in American history, being then absorbed by JP Morgan.
Earlier in March it was the turn of Silicon Valley Bank and Signature Bank, two more financial giants. In Europe, Credit Suisse and Deutsche Bank had to be bailed out by local governments to avoid disaster.
And today, after the Fed announced its decision, Pacific Western Bank (Pacwest)’s shares dropped by 50%. According to Bloomberg, the institution is looking for possible buyers as of this morning.
As of the last quarter of 2022, Pacwest held $41 billion in assets. Its failure would not be as threatening to the US economy as that of First Republic. Indeed, it would confirm the prediction of Jamie Dimon, CEO of JP Morgan. Following its acquisition of First Republic, Dimon said the worst of the crisis was over, and that only smaller and smaller institutions would fail in the future.
How long can banks take it?
In its statement following the rate hike, the Federal Reserve assured once again that the banking system is sound and resilient.
Nevertheless, the Fed also signaled this would be the last of its hikes. “The committee will take into account,” reads the Fed’s statement, “the cumulative tightening of monetary policy, the lags with which the monetary policy affects economic activity and inflation, and economic and financial development.”
Essentially, if inflation finally starts to come down from this month, the Federal Reserve will seriously consider stopping rate hikes.
In the statement, the Fed also recognized the modest GDP growth of the United States, an indicator of a slowing economy. To avoid recession, if at all possible, rates will have to start coming down by the end of the year.
Essentially, the banking system will have to hold until at least the last quarter of 2023. By then, inflation should have reached the target point of 2% and rates will have started coming down, hopefully.
The decision to raise interest rates was unanimous within the Fed committee, and pausing interest rate hikes was never an option. At the moment, US inflation is at 5% and core inflation is at 5.6%.
Will it really be the last interest rate hike? Will the economy avoid a recession? Only time will tell.
