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Powell Signals More Rate Hikes, Warns on Debt Ceiling, However ... SVB and Payroll Data May Change the Calculus 

March 13, 2023

Powell delivered his Semi-Annual Monetary Policy Report to Congress last week, and it wasn’t pretty. The Fed Chair signaled further Fed tightening amidst robust economic growth and massive job gains.

In his testimony, Powell noted:

“Although inflation has been moderating in recent months, the process of getting inflation back down to 2% has a long way to go and is likely to be bumpy.”

Powell also issued a strong warning to Congress to mind the debt limit, saying failure to do so “could be extraordinarily adverse and could do long-standing harm.”

Why it matters: The Chairman’s warning made it clear that the combination of not raising the debt limit and the potential for further rate hikes could very likely push the US into recession. Today’s inverted Treasury curve (2-year at 4.59% and 10-year at 3.70% as of 3/11/23) suggests a U.S. recession may be near. An inverted yield curve has accurately predicted the ten most recent recessions.

What we know now is…

• After a series of 50 and 75 basis point increases last year, the Fed raised interest rates by 25 bps in February, bringing its target range to 4.50 – 4.75%.
• The Fed is set to meet on March 21 – 22. A return to larger increases would represent a significant deviation in Fed policy and suggest that the peak in interest rates may be higher than the 5.3% priced in by markets.
• More and larger rate hikes have the potential to push the U.S. into recession.

Minding the debt limit…

• Republicans have vowed to not raise the debt ceiling unless Democrats agree to spending cuts.
• The US government hit its statutory debt limit in mid-January. However, ‘extraordinary measures’ are being applied to pay the country’s bills through early June.
• The standoff is a dangerous one, as a potential US debt default would prove catastrophic for the US economy and its global standing.
• Determining what to cut seems to be the stumbling block for Republicans, who have ruled out using new tax revenues to reduce the debt and remain divided over any cuts to military funding.

SVB’s Impact on the Fed. Following Powell’s testimony on Wednesday, markets placed the likelihood of a 50-basis-point increase at 80%. However, the odds plummeted to 28% by Friday, suggesting a 25-basi- point increase was more likely.

The reversal started on Thursday with the crisis at Silicon Valley Bank (SVB) raising concerns of contagion to other lenders. While SVB’s demise was not strictly linked to higher benchmark rates, the Fed’s fight to bring down inflation by raising rates aggressively is no doubt taking its toll on lenders forced to pay higher rates to attract deposits.

Then, on Friday, as SVB collapsed, payroll data showed an uptick in the unemployment rate and a slowdown in wage growth, hinting at less pressure on wage inflation.

“Does the Fed really want to add on when inflation is clearly subdued?” said David Kelly, Chief Global Strategist at JPMorgan, in an article for Financial Times. “There is not a thing in this data today suggesting the Fed should raise by 0.5 percentage points.”

What's next: The Fed enters its quiet period this week in advance of the March FOMC meeting. Markets will pay keen attention to CPI and PPI releases on Tuesday and Wednesday; both are expected to show some weakening.

As the CREFC Team wrote on Sunday afternoon, Signature Bank was closed by New York state regulators. Upon receiving a recommendation from the FDIC and Federal Reserve, Secretary Yellen approved actions enabling the FDIC to complete its resolution of SVB and Signature in a manner that:

·        Protects all depositors and

·        Prevents any losses associated with the resolution from being borne by taxpayers.

A bank run sparked by uncertainty over SVB’s finances wiped out more than $42 billion of deposits from its balance sheet last week, prompting California regulators and the FDIC to intervene. The above announcement included the news that Signature Bank also was closed on Sunday. Like SVB, all Signature depositors will be made whole and no losses will be borne by taxpayers.

The collapse of the both banks has elevated concerns of instability at small- and mid-sized financial institutions. Bloomberg reported that the Fed and Treasury are preparing emergency measures to shore up banks and meet withdrawal demands. To that end, the Fed announced the creation of a Bank Term Funding Program (BTFP) that will allow banks to pledge Treasuries, agency MBS, and other eligible collateral for loans at par value. The Fed’s discount window also remains open and apply the same margins as the BTFP.

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