Bank Failures, Market Turmoil Fuel Bets on a Pause in Fed Interest-Rate Increases

Officials have raised rates at each of their last eight policy meetings, spanning 12 months, in what has marked the most rapid series of increases since the early 1980s to combat inflation that last year touched a 40-year high.

U.S. government bond markets rallied aggressively amid broader worries Wednesday about the health of the banking system, putting stress on trading as investors worried about what the bank turmoil could mean for the economy.

Investors generally agreed that fear of economic distress was driving down interest-rate expectations and prompting investors to dump riskier assets in favor of safer ones, following the U.S. bank rout and a sharp decline Wednesday in shares of Swiss lender Credit Suisse Group AG.

“Financial crises create demand destruction. Banks reduce credit availability. Consumers hold off large purchases. Businesses defer spending,” former Boston Fed President Eric Rosengren said Wednesday on Twitter. “Interest rates should pause until the degree of demand destruction can be evaluated.”

Financial markets broadly showed signs that investors saw a broader banking crisis could lead to slower economic growth and less demand. U.S. stocks slid. Prices of crude oil fell more than 6%, while prices of copper—which can be a harbinger of growth due to its many industrial uses—were off more than 3%.

Banking industry turbulence overshadowed February economic figures showing a decline in retail sales and easing price pressures, early signs of a cooling economy after a hot start to the year. The Fed and investors were hyper focused on economic readings prior to the bank failures, which includes Signature Bank.

The uncertainty over the Fed’s rate path led trading in futures markets to imply expectations that the central bank could start lowering rates by June. On Wednesday, markets saw a nearly 80% chance that by year’s end, the Fed would cut rates from current levels by at least 1 percentage point.

That would mark a stunning reversal from one week ago, when comments from Fed Chair

Jerome Powell

ahead of the bank failures indicated the central bank might make a larger half-percentage point increase in its benchmark policy rate. That drove investors to anticipate rates might rise to 5.6% later this year.

He made those comments before concerns over losses on securities owned by Silicon Valley Bank sparked a run that forced an aggressive intervention by bank regulators and the Treasury Department on Sunday to shore up confidence among customers of small and midsize banks.

Those steps were aimed at avoiding broader financial stability so that the Fed could maintain its focus on more gently cooling down the economy with rate increases. 

The Fed raises rates to fight inflation by slowing demand for goods and services, and officials say their policies operate primarily through tighter financial conditions—such as higher borrowing costs, lower stock prices and a stronger dollar. But the effects of those policies don’t show up right away, and they don’t want financial conditions to tighten in a way that spirals out of control.

A more severe breakdown in funding markets, including the buying and selling of U.S. Treasury securities, could create even more difficult decisions for the Fed. The central bank is in the process of shrinking its $8.3 trillion asset portfolio, which includes $5.3 trillion in Treasurys.

Last September, the Bank of England confronted a crisis sparked by a run-up in government bond yields that, in turn, sparked large sales of those bonds, driving prices down and yields up. The central bank faced the tricky task of buying government bonds, which can provide a form of stimulus, to stabilize disrupted markets at the same time it was trying to tighten policy to fight inflation.

Write to Nick Timiraos at [email protected]

Officials have raised rates at each of their last eight policy meetings, spanning 12 months, in what has marked the most rapid series of increases since the early 1980s to combat inflation that last year touched a 40-year high.

U.S. government bond markets rallied aggressively amid broader worries Wednesday about the health of the banking system, putting stress on trading as investors worried about what the bank turmoil could mean for the economy.

Investors generally agreed that fear of economic distress was driving down interest-rate expectations and prompting investors to dump riskier assets in favor of safer ones, following the U.S. bank rout and a sharp decline Wednesday in shares of Swiss lender Credit Suisse Group AG.

“Financial crises create demand destruction. Banks reduce credit availability. Consumers hold off large purchases. Businesses defer spending,” former Boston Fed President Eric Rosengren said Wednesday on Twitter. “Interest rates should pause until the degree of demand destruction can be evaluated.”

Financial markets broadly showed signs that investors saw a broader banking crisis could lead to slower economic growth and less demand. U.S. stocks slid. Prices of crude oil fell more than 6%, while prices of copper—which can be a harbinger of growth due to its many industrial uses—were off more than 3%.

Banking industry turbulence overshadowed February economic figures showing a decline in retail sales and easing price pressures, early signs of a cooling economy after a hot start to the year. The Fed and investors were hyper focused on economic readings prior to the bank failures, which includes Signature Bank.

The uncertainty over the Fed’s rate path led trading in futures markets to imply expectations that the central bank could start lowering rates by June. On Wednesday, markets saw a nearly 80% chance that by year’s end, the Fed would cut rates from current levels by at least 1 percentage point.

That would mark a stunning reversal from one week ago, when comments from Fed Chair

Jerome Powell

ahead of the bank failures indicated the central bank might make a larger half-percentage point increase in its benchmark policy rate. That drove investors to anticipate rates might rise to 5.6% later this year.

He made those comments before concerns over losses on securities owned by Silicon Valley Bank sparked a run that forced an aggressive intervention by bank regulators and the Treasury Department on Sunday to shore up confidence among customers of small and midsize banks.

Those steps were aimed at avoiding broader financial stability so that the Fed could maintain its focus on more gently cooling down the economy with rate increases. 

The Fed raises rates to fight inflation by slowing demand for goods and services, and officials say their policies operate primarily through tighter financial conditions—such as higher borrowing costs, lower stock prices and a stronger dollar. But the effects of those policies don’t show up right away, and they don’t want financial conditions to tighten in a way that spirals out of control.

A more severe breakdown in funding markets, including the buying and selling of U.S. Treasury securities, could create even more difficult decisions for the Fed. The central bank is in the process of shrinking its $8.3 trillion asset portfolio, which includes $5.3 trillion in Treasurys.

Last September, the Bank of England confronted a crisis sparked by a run-up in government bond yields that, in turn, sparked large sales of those bonds, driving prices down and yields up. The central bank faced the tricky task of buying government bonds, which can provide a form of stimulus, to stabilize disrupted markets at the same time it was trying to tighten policy to fight inflation.

Write to Nick Timiraos at [email protected]