The Federal Reserve Increases Interest Rates By 0.25%

The Federal Reserve hiked interest rates for the ninth time in a row, signaling that it is confident that its efforts to combat inflation would not exacerbate a brewing financial crisis.

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The Federal Open Market Committee voted unanimously to raise the federal funds rate target by a quarter percentage point to a range of 4.75%–5%, the highest since September 2007, when rates peaked on the brink of the financial crisis. That is the second consecutive 25-basis-point increase, following a series of aggressive hikes beginning in March 2022, when rates were near zero.

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"We are committed to restoring price stability, and all evidence indicates that the public has confidence in our capacity to do so," Fed Chair Jerome Powell said during a news conference concluding the Fed's two-day meeting. "It is critical that we demonstrate our confidence via our deeds as much as our words."

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Regulators are ready to boost rates even higher if necessary, he added.

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Powell also emphasized the soundness and resilience of the United States banking system, echoing what officials said in their post-meeting statement, and stated that the agency is prepared to utilize all of its instruments to ensure stability.

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He also admitted that recent banking upheaval is "likely to result in tighter credit conditions for families and companies, which would, in turn, impair economic results," but added that "it's too early to say how monetary policy should respond."

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Fed officials anticipated that interest rates would finish 2023 at around 5.1%, unchanged from their December median projection. The median 2024 prediction increased from 4.1% to 4.3%.

Treasury rates fell along with the US currency following the announcement, but markets climbed.

The rise and estimates indicate that authorities are still intent on lowering inflation to their 2% target, implying that they perceive increasing prices as a greater danger to the economy than the financial crisis. It also conveys confidence that the economy and financial system are strong enough to weather the recent run of bank failures.

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At the same time, increased borrowing costs risk exacerbating the bank crisis, especially given that it was higher interest rates on treasuries that caused Silicon Valley Bank to fail and endangered other institutions. If the Fed underestimates the degree of financial cracks, the current action risks exacerbating pressures that might tip the economy into recession.

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Powell stated that the Fed would welcome an outside investigation into the apparent oversight failures at SVB and that he intends to support tighter bank supervision and regulation if suggested by the Fed's Vice Chair for Supervision, Michael Barr.

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"During that first weekend, we were all asking ourselves, 'How did this happen? He added.””

Tough call

While the raise on Wednesday was in line with most economists' and traders' predictions, it was one of the Fed's most difficult decisions in recent years, with some Fed watchers and investors pushing for a delay to reduce the danger of financial contagion following several bank failures.

Officials stated in a post-meeting statement that the Fed "anticipates that some more policy firming may be needed in order to achieve a stance of monetary policy that is sufficiently restrictive to restore inflation to 2% over time."

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When asked about the shift in phrasing, Powell replied, "Actually, I would focus on the words may and some.'" He added that the Fed does not foresee a rate reduction this year.

He also stated that policymakers contemplated pausing their interest-rate hike campaign in light of the banking upheaval, but the consensus for a rise was solid, noting recent data indicating "inflation pressures continue to run high."

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The change in statement phrasing – before, officials had stated that "ongoing hikes" in the benchmark rate would be acceptable - indicates that they wish to offer flexibility to halt if required.

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Authorities also deleted a reference to inflation having lessened from the statement, stating that price pressures remain elevated. It highlighted that employment growth has accelerated in recent months and is "going at a healthy pace."

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The Fed said it will keep lowering its balance sheet at the same rate, a process known as quantitative tightening, even if recent emergency measures had increased assets. The Fed will maintain monthly limits of $60 billion for treasuries permitted to mature without being reinvested and $35 billion for MBS.

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Before the SVB collapse, Powell hinted that the Fed would return to a 50 basis-point rise at this meeting to address persistent inflation and an overly tight labor market. The policymakers' meeting this week was the first since the January and February figures came in shockingly hot.

The failure of SVB and two other banks in the United States was followed by the sale of Swiss banking behemoth Credit Suisse Group AG in Europe.

Fears of contagion

Fears of contagion to other institutions arose as a result of the turbulence. Backstops were put in place by the Fed and other regulatory agencies, including an emergency loan facility for banks and an increase in the frequency of US dollar swap-line transactions with foreign central banks, which the Fed and five other institutions announced on Sunday.

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The events of the previous two weeks had raised uncertainty about what the Fed would do at this meeting.

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Fears about a lack of liquidity have also grown. According to data released last week, banks in the United States borrowed a record amount from Fed backup facilities in the week ending March 15, breaking a previous high set during the 2008 financial crisis and indicating widespread financing problems.

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This adds to predictions that the Fed will cut rates at some point this year, which most investors did not expect before the bank collapses and which Fed officials consistently stressed would not happen.

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