Federal Reserve May Pause Rate Hikes As Bank Stocks Keep Sliding

Wall Street suddenly sees a solid chance that the Federal Reserve will pause its rate-hiking campaign at next week’s meeting as the failure of three banks stokes concern about broader financial-sector stress. Despite forceful moves by the Fed and other regulators to shore up confidence in small and midsize banks over the weekend, sellers hammered bank stocks in Monday stock market action.


At the least, the nearly overnight collapse of Silicon Valley lender SVB Financial Group — caused in large part by losses stemming from bond market investments — made clear that the Fed needs to change course and tighten policy at a deliberate pace from here on out. Half-point moves are now off the table — just a week after Fed chair Jerome Powell signaled that policymakers were ready to reaccelerate rate hikes at next week’s meeting from February’s quarter-point pace.

Now a sharp dive in Treasury yields is signaling sudden doubts about the strength of the economy. Even if the Fed doesn’t pause next week, markets are betting that rate cuts are around the corner.

Federal Reserve Rate Hike Odds

On Monday, odds of no hike at next week’s Fed meeting surged past 50% from 0% a week ago, before settling back to 21% mid-afternoon. Odds of a half-point hike, which surged above 80% after Powell’s Senate testimony last Tuesday, are now zero.

Powell had appeared ready to step up the pace of rate hikes because jobs and inflation data are still coming in too hot for the Fed’s comfort. But the sudden financial-sector fragility roadblocks the Fed’s ability to more forcefully restrain inflation.

Most Wall Street economists seem to be sticking with projections of a quarter-point hike, but Goldman Sachs economists said Sunday that they expect the Fed to stand pat. However, Goldman still expects three more quarter-point hikes in May, June and July.

Yet markets also are indicating a dramatic shift in expectations for Fed policy later this year. Now Wall Street expects the Fed’s key rate to end the year between 4% and 4.25%, down from 5.25% to 5.5% a week ago.

On Monday, the one-year Treasury yield dived 50 basis points to 4.37%, continuing its slide from 5.2% last Tuesday. The 10-year Treasury yield tumbled 17 basis points to 3.53%.

Rapid Rate Hikes Stress Banking Sector

The failure of SVB, as well as Signature Bank and Silvergate Bank, has exposed several ways that the most-aggressive Fed tightening in four decades is putting pressure on the banking sector.

SVB’s problems arose because of heavy exposure to startups, whose deposits surged in 2021 amid healthy venture funding, but have lately been rapidly spending down their cash. Meanwhile, SVB put much of those deposits into government-backed mortgage backed securities before the spike in rates. As market yields surged, the value of those low-risk bonds tumbled.

For a time, SVB was OK. That’s because regulators allow for financial statements to treat certain fallen bonds as if they haven’t lost value, assuming a bank plans to hold them to maturity. But it turned out SVB didn’t have that luxury. Because of an outflow of deposits, SVB needed to raise cash, selling part of its bond portfolio for a heavy loss.

Short-term Treasuries have also weighed on the banking sector more broadly, recently offering 5%-plus risk-free returns on cash until the past couple of days, leading to an outflow of deposits. While banks have been raising their lending rates, the higher rates are an impediment to borrowing, particularly as the Fed tries to engineer an economic slowdown.

Now, with the health of smaller and midsize banks suddenly under intense scrutiny and their stocks under pressure, depositors might think about moving their money.

Fed, FDIC Stage Bank Rescue

The Fed, FDIC and Treasury Department moved to shore up confidence by announcing that even SVB and Signature Bank depositors not backed by FDIC insurance above $250,000 will be made whole. Some analysts said that sets a precedent for a government guarantee of deposits that aren’t covered by FDIC insurance.

The Fed also announced a one-year bank term funding program to offer small and midsize banks a solution to a key problem that had plagued SVB.

If the new Fed program had been in place, SVB would have been able to tap a Fed loan by putting its fallen bonds up as collateral, avoiding the need to sell at a loss.

Bank Stocks Still Under Pressure

Despite those move, confidence in smaller banks and even not-so-small financial institutions still appeared shaken. First Republic Bank (FRC)  plummeted 52%. Charles Schwab (SCHW) fell 9%, but battled back from deeper losses. Even bank titans were under pressure, with Wells Fargo (WFC) down 5%, Bank of America (BAC) 3.75% and Citigroup (C) more than 5%.

In most cases, the selling may reflect worries about profitability more than solvency. Federal officials said the rescue of SVB and Signature Bank depositors will eventually be paid for by higher deposit insurance fees from covered banks. There’s also concern that banks will have to offer customers better deposit terms to limit outflows.

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