Banking Chaos Could Prompt Fed to Slow or Pause Rate Hikes

The Silicon Valley Bank failure will likely lead the Fed to back off from the hawkish stance it laid out last week, forecasters said

Members of the media interview a Silicon Valley Bank customer outside of the bank office on March 13, 2023 in Santa Clara, California. Days after Silicon Valley Bank collapsed, customers are lining up to try and retrieve their funds from the failed bank. The Silicon Valley Bank failure is the second largest in U.S. history.

Justin Sullivan / Getty Images

Federal Reserve officials just last week seemed intent on raising interest rates. Now the chaos in the banking system has called that into question. 

Failures at Silicon Valley Bank and Signature Bank prompted the Fed, Treasury Department and FDIC to step in to protect depositors, backstop the banking system and reassure the public that their money was safe in the nation’s banks over the weekend.The Federal Reserve also called an "expedited" closed-door meeting for Monday, with the discount rate on the agenda.

Traders have downshifted their expectations for the path of the Fed’s anti-inflation rate hike campaign as a result. Market participants on Monday mostly expected the Fed to hike its benchmark fed funds rate a quarter-point at its March 22 meeting, a retreat from the half-point hike traders anticipated last week, according to the CME Fedwatch tool, which forecasts rate hikes based on trading data. The data even implied about a one-in-three chance the Fed would leave the rate flat. 

Economists at Goldman Sachs were among those anticipating the central bank would back off its rate hikes in the name of keeping the banking system stable. 

“In light of recent stress in the banking system, we no longer expect the FOMC to deliver a rate hike at its March 22 meeting with considerable uncertainty about the path beyond March,” Jan Hatzius and a team of Goldman Sachs economists said in a research note Sunday.

The crisis highlights how the central bank’s policy goals often conflict. The Fed is charged with using its monetary policy to promote “price stability” and “maximum employment,” and with the job market running hot, the Fed has been focused on the inflation-fighting part of its mandate for the past year. Officials have raised the Fed’s benchmark interest rate to its highest since 2007 in an effort to slow the economy and allow supply and demand to rebalance, potentially at the cost of causing a recession. 

Last week, Fed chair Jerome Powell told lawmakers to expect the Fed to hike rates higher and faster to counteract inflation that has proved more stubborn than expected. 

The failure of Silicon Valley Bank showed that those rate hikes have also put the financial system under pressure, threatening to undermine the Fed’s other core mission of keeping the banking system stable. 

The Fed’s hikes over the last year contributed to the failure of Silicon Valley Bank in at least two ways. The bank had a large portion of its assets invested in long-term bonds, which have fallen in value because of the rate hikes.  Not only that, but the hikes—which have made all kinds of loans more expensive throughout the economy—especially hurt the bank’s clientele, which are primarily startup tech companies that thrived on cheap loans and easy credit during the long era of near-zero interest rates. 

To be sure, many economists don’t believe two bank failures will be enough to make the Fed take its focus off inflation and halt rate hikes.

“Inflation is still persistently high,” Megan Greene, an economist and senior fellow at the Harvard Kennedy School posted on Twitter. “The recent financial market wobbles … won’t change this.”

Still, the SVB collapse served as “a timely reminder that when the Fed is singularly focused on squeezing inflation by jacking up interest rates – it often ends up breaking things,” economists at Capital Economics said in a commentary on Friday.

The Federal reserve system was created in 1913 to stabilize the U.S. financial system, which had proved chaotic and prone to disastrous panics and widespread bank failures. 

As of Monday, the SVB episode looked to be more of a “wobble” than a broader collapse, and it could prompt the Fed to be more cautious in its future rate hikes, analysts at ING said in a commentary. ING forecast the Fed would back off its plans for a 50-point hike and stick with a 25-point one instead.

The Fed’s rate hike decision could hinge on the official report on inflation for February when it’s released Tuesday. Economists expect the Consumer Price Index to show year-over-year inflation cooling to 6.1% from 6.4% in January.

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  1. Federal Reserve. "Federal Reserve Board announces it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors."

  2. Federal Reserve Board. "Closed Board Meeting on March 13, 2023."

  3. CME Group. "FedWatch Tool."

  4. Federal Reserve. "Open Market Operations."

  5. Twitter. "@economistmeg, 10:47 p.m., March 12, 2023."

  6. Capital Economics. "SVB collapse a reminder of financial risks."

  7. ING. "Assessing the Silicon Valley Bank fallout."

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