The Federal Reserve has raised interest rates by a quarter of a point, leaving them in a band that goes from 5% to 5.25%. It is the highest level since September 2007. But that is not the news. What is relevant is that, when announcing the decision, the ‘Fed’ has declared that, in the future, when deciding interest rates, “we will take into account the cumulative impact of the tightening of monetary policy, the delay with the that monetary policy affects economic activity and inflation, and economic and financial events”. It is a phrase similar to the one used by the central bank in 2006, when the last great cycle of interest rate rises ended.
Similarly, the ‘Fed’ removed from the statement issued after its last meeting, six weeks ago, the phrase “a certain reinforcement of the firmness of the policy will be appropriate with the aim of achieving a monetary policy position that is sufficiently restrictive” . That nice way of writing, clearly intended so that nobody understands what he means, is how the ‘Fed’ explained that it was going to continue raising rates. Now, the phrase has been deleted from the statement.
That means that the US stops raising interest rates for the time being, unless circumstances change. The upward cycle in the price of money that began fifteen months ago has therefore come to an end. Now it’s time for a period of review of the situation, which will probably last at least three months, until the Federal Reserve adopts a clearer position. At their last meeting, in March, the members of the Federal Open Market Committee (FOMC), which is the body of the ‘Fed’ that decides on monetary policy, pointed out that interest rates they would not rise above 5.1%. That is the level they are at now.
Variable income, predictably, has reacted with rises to the words of the Federal Reserve, while the dollar fell in relation to the euro, as well as the price of oil. However, the market remains cautious, since the ‘Fed’ has not said that the price of money is “appropriate”, which is the key word. Measured in relation to the inflation indicator preferred by the ‘Fed’, the private consumer price index, US interest rates are positive, that is, higher than price growth. That applies to both the headline and the core index, which does not include the most volatile elements of the indicator, which are energy and food.
This has been the tenth rise since the US central bank began raising interest rates fifteen months ago, in an attempt to stem the biggest burst of inflation in four decades that has left the prestige of all markets in tatters. central banks and most of the international organizations – including the IMF – which had foreseen a much less intense and temporary rise in world prices. While the United States seems to be nearing the end of the rate hike cycle, in the euro area the market is still expecting more hikes.
The decision comes at a very difficult time for the US economy. The economy is slowing down, and the midsize bank crisis that began almost two months ago with the intervention of Silicon Valley Bank (SVB), which was the 16th largest bank in the US by assets, has continued this week with the intervention and subsequent sale of First Republic, an even larger entity.
If the financial sector’s problems worsen, the credit crunch caused by rate hikes could combine with a tightening of banks to grant loans, given the growing delinquencies and the loss of value of their portfolio of Treasury bonds (if they rise interest rates, the value of bonds falls, and vice versa). The chances of a ‘balance sheet recession’ have grown, although the Federal Reserve has tried to offset them by creating a special funding window for troubled banks. It is a paradoxical measure, given that it involves injecting liquidity to the banks on the one hand while, on the other, with rate hikes, this is reduced.
The rate hikes have been combined with a reduction in the portfolio – what is normally known as the balance – of the Federal Reserve, which had been inflated with the purchase by the issuing institution of Treasury and mortgage bonds in the market between March 2020 and February 2021 to counteract the economic contraction caused by Covid-19. When the ‘Fed’ buys debt, it increases the liquidity of the market, since it has to pay for it to the financial institutions that have it in their portfolios. In turn, when it sells debt, it removes liquidity, since it is the banks and funds that have to pay the central bank to get hold of the titles. The extent of the impact of the debt sale on market liquidity has, however, been the subject of debate, between those who believe that it has been considerable and those who see it as rather insignificant.
According to the criteria of The Trust Project
