Ear to the Ground

May 05 2023

The US Federal Reserve (Fed) and European Central Bank (ECB) were back at the table this week to discuss interest rates once again.  As expected, the Fed increased the Fed funds rate by 0.25% to the 5%-5.25% range.  This marked the tenth increase which we have seen and the rate now stands at its highest level since September 2007.

The Fed is now expected to pause in its hiking cycle and it was noticeable that there was no direct reference in the statement released pointing to the need for additional hikes.  Scope was still left for further rises if required however, with the central bank stating that monetary policy moving forward will take into consideration the tightening of monetary policy we have already seen, the lag in impact which is often seen from this, along with future inflation, economic and financial developments. 

For some, the statement wasn’t as dovish as they were expecting, with the Fed still appearing to be pushing back against interest rate cuts this year.  The market however, as reflected through Fed funds futures, continues to believe that rate cuts are on the cards.  Futures currently suggest the rates could be as low as 4.25% by the end of the year, implying a quick change of heart from the central bank.

During the press conference which followed, the Fed were also keen to state that they believed that the banking system is “sound and resilient.”  Less than two hours later however we saw a further collapse in the share price of regional banks as PacWest announced that they were looking for a buyer.  The repercussions of this, along with the other issues we have seen in the regional banking sector, have been significant in terms of these companies share prices.  The SPDR S&P Regional Banks ETF is now down over 44% at the time of writing since the 2nd February, on a price only, US dollar basis.

The expectation is that issues in this sector will lead to a tightening in lending standards and conditions.  This is certainly expected at the corporate level, with a Bloomberg analysis of company earnings calls has shown a sharp rise in the mention of ‘credit tightening’, indeed reaching a level which is higher than that seen during the global financial crisis.  This will more likely than not contribute to a slowdown in economic activity at some point moving forward, and it is perhaps this reason why the market is expecting the Fed to cut more aggressively.

Issues in the US banking sector have reached the shores of the UK.  Figures from the Bank of England showed that £4.8bn was pulled out of UK bank and building society accounts in March, the highest figures since records began in 1997.  Instead, households preferred National Savings and Investment accounts, where £3.5bn was deposited. 

This ECB also raised their base rate equivalent by 0.25%, taking it to 3.75%, which was in line with expectations.  This is the seventh consecutive rate hike and now stands at the highest level since July 2008.  At the press conference which followed, President Lagarde commented that the ECB still have more ground to cover and that it was not pausing the rate lifting cycle anytime soon.

All eyes will next be on the Bank of England.  A further rate rise of 0.25% is expected, taking the base rate to 4.5%.  

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