With a banking crisis in full swing, how will the Federal Reserve respond?

Fears of a worldwide financial crisis, precipitated by the failure of three US banks in the last two weeks, continue to weigh on the shares of other financial institutions despite efforts by central banks and politicians to allay concerns.

After receiving a £45bn emergency loan from the Swiss National Bank only days before to shore up its liquidity following a week of panic, Credit Suisse (SIX:CSGN), Switzerland's second-biggest bank, was bought yesterday by the American bank UBS for 3 billion Swiss francs ($3.23 billion). Its shares drop by 26% last week at 1.85.


Credit Suisse Daily Chart - Source: ActivTrades’ online trading platform

U.S. bank, First Republic Bank, also recently had its share price drop (by almost 14% last week), despite receiving a $30 billion infusion of emergency cash from America's big banks as part of a deal brokered by US Treasury Secretary Janet Yellen and Federal Reserve Chairman Jerome Powell.

Before these events started to unfold, many financial analysts forecasted that the Federal Reserve would likely quicken the pace of rate rises, permitting a half-point increase in rates next week after just a quarter-point increase the previous month.

When Fed Chair Powell addressed Congress at the beginning of the month, he intimated that there was still room to be aggressive with monetary policy to keep inflation at bay. However, with the failure of SVB, Signature, and Silvergate, analysts like those working for Goldman Sachs (NYSE:GS) have suggested that they no longer anticipate the Fed to raise interest rates this month.

It is still unclear how Fed officials will react to the recent difficulties in the banking sector. Some clarity will emerge on Wednesday, when the FOMC concludes its next policy meeting with its statement due at 6:00 PM GMT, and announces how much it will raise interest rates—or whether it will do so at all.

The fall of a forty-year institution

After shocking investors late on Wednesday the 8th of March with the revelation that it needed to raise $2.25 billion to strengthen its balance sheet, Silicon Valley Bank’s devastating downhill spiral began. What came next was the swift demise of a reputable bank that had developed alongside its tech clientele since it was founded in 1983.

SVB found itself short on funds as startup customers withdrew deposits to keep their firms viable in a frigid climate for IPOs and private funding. The bank stated late Wednesday that it had been compelled to sell all its available-for-sale bonds at a $1.8 billion loss. At the time the bank purchased these bonds, in a low-interest rate environment, the investment had looked secure. Once inflation increased and interest rates soon followed, which weighted on bonds’ value and then the bank was forced to sell them.

The unexpected need for new funding, after the collapse of crypto-focused Silvergate bank, spurred another wave of deposit withdrawals the following Thursday as VCs urged their portfolio businesses to relocate assets.

According to a California regulatory filing, consumers withdrew a stunning $42 billion in deposits by the end of Thursday and SVB had a negative cash balance of $958 million at the end of the business. The bank had failed to get sufficient collateral from other sources, and the doors were shuttered.

The soft landing just gets narrower

As a result of all the recent difficulties in the banking industry, some economists are suggesting it is possible that a recession may become much more widespread and may appear sooner rather than later in the US.

For months now, an inverted Treasury yield curve has signaled a coming economic slowdown, while market players have been divided about whether this would turn out to be a soft landing or a hard one.

The Fed’s rate rises haven’t hit the mark terribly well just yet either. Consumers and companies are still doing well in almost every industry, owing in part to remaining savings from the pandemic's spike in government expenditure. It's also partly because of chronically low unemployment and high pay increases, which is attributable, in some part, to many companies’ desire to stockpile labor following years of worker shortages.

To hike or pause?

The Federal Reserve continues to stress that there is still work to be done to raise interest rates further in order to help control inflation before it becomes too entrenched. Nevertheless, they’re now faced with the tough decision of either taming prices or risking further deterioration in the banking sector and triggering a deeper recession.

Given the current state of the global markets, many Fed observers anticipate a lower, quarter-point rise, and others believe the bank will take a complete break after its two-day meeting beginning on March 21st.

An update to the Fed's summary of economic projections, the quarterly report that details members' predictions for everything from inflation to interest rates, as well as Fed chair Jerome Powell's post-meeting press conference, will also be eagerly awaited outcomes of this coming meeting.