In recent days, a banking crisis has emerged as a powerful new constraint on a red hot US economy that the Federal Reserve has struggled for more than a year to cool. The crisis has been triggered by runs on regional US banks and wild gyrations in stocks and bonds, causing bankers to abandon attempts to raise new funding for their corporate clients. Not a single investment-grade company sold bonds in the US market last week, marking the first sign of what’s set to be a broad-based hit to the provision of credit across the economy.
A rush for safety outside of banks saw money-market funds attract the biggest weekly inflow since April 2020. With deposits already sliding in the run-up to three bank collapses that triggered the biggest selloff in financial stocks since the Covid panic of spring 2020, the pace of lending to companies and households alike is bound to shrink, according to economists.
As Fed Chair Jerome Powell and his colleagues gather for a pivotal two-day policy meeting, the question is whether the brakes have been suddenly slammed too hard. The central bank wanted a slowdown — something seen as essential to tame inflation — but not a crisis capable of sinking the economy into a deep recession.
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FED faces a dilemma over ditching a rate increase
Ditching a March 22 rate increase would give the Fed the chance to gauge the seriousness of the current turmoil and the effectiveness of the steps it’s taken to shore up banks’ liquidity. However, that strategy also risks spooking the public into thinking the central bank sees a major systemic crisis under way — a danger that convinced the European Central Bank on Thursday to go ahead with its own rate hike. An additional concern: if the crisis fades, failing to act in March could further entrench inflation.
What makes things all the more complicated for Powell and his team is that they’re also due to release updated projections for where they see the benchmark rate at the end of 2023 and 2024. Those are updated every quarter, and on this occasion come on the heels of the second-biggest US bank failure in history.
Bank of America attracts $15 billion in new deposits amid banking turmoil
Despite the Fed’s moves a week ago to ring-fence the broader banking sector from the meltdown of Silicon Valley Bank, last week saw an exodus of deposits from smaller and regional banks and toward larger ones. Bank of America Corp. mopped up more than $15 billion in new deposits in a matter of days, according to Bloomberg. In another sign of emergency demand for funding, banks borrowed a combined $164.8 billion from two Fed backstop facilities in the most recent week, according to a report.
Deposits at smaller banks stabilize, but credit pullback anticipated
While Deputy Treasury Secretary Wally Adeyemo said on Friday that, based on discussions regulators have had with banking executives, deposits at small- and medium-sized banks across the country had begun to stabilize and in some cases “modestly reverse,” economists are broadly anticipating a pullback in credit. Smaller-sized lenders account for a disproportionate share of overall lending to companies and households, amplifying the impact of their recent woes.
