Saturday , 13 July 2024
Home Business Between Inflation and Banking Crisis: Why the U.S. Federal Reserve Raised Interest Rates for the Ninth Time in a Row
Business

Between Inflation and Banking Crisis: Why the U.S. Federal Reserve Raised Interest Rates for the Ninth Time in a Row

Photo by Jon Tyson on Unsplash

The U.S. Federal Reserve raised its interest rate range by 25 basis points to 4.75-5% per annum, the highest level since fall 2007. This decision was made by the Federal Reserve’s Open Market Committee at the end of its two-day meeting.

The Fed has raised its interest rate for the ninth time in a row. The American regulator is trying to restrain the significant acceleration of price growth in the country through such tightening of monetary policy (MP). However, as head of the agency Jerome Powell said, the process of fighting inflation “will be a long one.

“When it comes to the economy and monetary policy in general, inflation remains too high and there remains great tension in the labor market. My colleagues and I understand the difficulties that inflation is causing, and we remain strongly committed to our goal of bringing it down to 2 percent,” TASS quoted Powell as saying.

Inflation in the USA began to grow steadily in 2021 against the background of the COVID-19 pandemic. Then the quarantine restrictions led to disruptions in supplies of a number of products that as a result caused a rise in consumer prices. At the same time, to support the economy, the Fed printed a significant amount of money that was not sufficiently backed by commodities.

The situation worsened in 2022 after Washington imposed sanctions against Moscow. In particular, the ban on energy supplies from Russia resulted in a shortage of fuel in the U.S. and, as a consequence, a sharp rise in the cost of fuel and other goods. Already in the middle of the year, inflation in the U.S. rose to 9.1% for the first time in more than 40 years, according to the U.S. Department of Labor.

In an effort to curb the record rise in prices, the U.S. had to use its strategic oil reserves, which are already empty almost by half. In turn, the Fed began to sharply increase the rate, although previously it had held it near zero for a long period.

Traditionally, the tightening of monetary policy is considered one of the main tools in the fight against rising prices. By raising interest rates, borrowed money becomes more expensive for citizens and businesses, consumer and business activity weakens, which puts pressure on inflation.

As a result of the Fed’s actions by March 2023, inflation in the U.S. has slowed to 6%. Nevertheless, rates are still three times higher than the Fed’s target of 2%.

In this regard, the management of the U.S. regulator considers it appropriate to further increase the interest rate. However, such a move could pose a threat to the financial system in the light of new events in the banking sector of the country, experts believe.

“Inflation in the States remains above target, and the Fed says it’s reluctant to pull out of its path before it finally defeats rising prices. On the other hand, we see a serious banking crisis, which is also the result of interest rate increases,” Alexander Abramov, head of the Laboratory of Analysis of Institutions and Financial Markets at the Institute of Applied Economic Research of the Russian Academy of National Economy and Public Administration, said in a conversation with .

Recall that in the first half of March in the U.S., with a difference of a few days three banks went bankrupt – Silicon Valley Bank (SVB), Signature Bank and Silvergate Bank – with total assets of almost $331 billion. And the first two were in the top 30 largest financial institutions in the United States.

After the incident, President of the United States Joe Biden appealed to citizens and assured that the banking sector “remains safe”. In turn, the U.S. Treasury and the Fed announced extensive measures to support the financial system. Nevertheless, the news of the collapse of several large companies provoked panic in the stock market of the country, and the value of shares of a number of U.S. banks began to decline sharply.

This was followed by a collapse of stock prices in Europe. As a result, for example, the second largest bank in Switzerland, Credit Suisse, founded back in 1856, was on the verge of bankruptcy and was eventually absorbed by the country’s largest financial holding UBS.

“It was the tightening of monetary policy that was the main cause of this banking crisis. Rising rates have made banks’ investments unprofitable, and weak reports from financial institutions have caused a strong outflow of capital and led to a shortage of liquidity. Under these conditions, further rate hikes could open a bleeding wound and trigger a new wave of bankruptcies,” BitRiver financial analyst Vladislav Antonov told .

Note that the Fed’s policies directly affect the government bonds (treasuries) market. Investors typically buy these securities from the U.S. Treasury and essentially lend their money to the U.S. economy, and then receive a steady income in the form of interest. As the Fed’s rate goes up, the yield on the Treasuries generally goes up but the price of the securities goes down.

According to experts, in recent years, U.S. banks have invested a significant amount of money in U.S. government bonds, including their depositors’ money. Meanwhile, against a background of a sharp increase of the FRS rate and cheapening of treasuries, portfolios of credit institutions began to depreciate rapidly. As a result, banks faced a shortage of money after the outflow of customers’ funds began.

“It is worth noting that the current situation is different from the events of 2008. At that time the crisis occurred due to the fact that many banks kept toxic assets in their portfolios, which in the end were worthless. Now the banks hold highly leveraged government bonds, but their value in 2022 has dropped 25% due to a rapid increase in the Fed Funds rate. This created panic and liquidity problems,” Alexander Abramov noted.

However, according to Jerome Powell, only a small number of American banks faced similar difficulties. As the head of the regulator noted, the financial system could be under threat if the problems of some financial institutions are not solved, but so far the situation remains stable.

“Our banking system is strong with sound capital and liquidity. We will continue to closely monitor conditions in the banking system and are prepared to use all of our tools to keep it safe, if necessary,” Powell said.

According to Alexander Abramov, the Fed expects that the recent challenges will remain local and will not escalate into a full-scale crisis. However, Vladislav Antonov believes that the U.S. authorities will begin to pump money into the financial system as part of their support for the banks, which risks a new wave of inflation.

“The Fed has backed up the central banks of Canada, England, Japan, the EU and Switzerland. If necessary, they will provide the Fed with dollar liquidity. In this case, the U.S. Treasury said they would help bank depositors if necessary. That is, the authorities are willing to pour money into the economy to show the world what a reliable banking system in the U.S., although it is beginning to burst at the seams,” said Antonov.

Under current conditions, the Fed, as well as regulators in other Western countries, will have to balance between the fight against inflation and risks to financial stability. At that, the current state of affairs may have negative consequences for the entire global economy, said the head of the Central Bank of Russia Elvira Nabiullina on March 17.

“On the one hand, we see the vulnerability of the financial sector (in the West. – ) to interest rate and other risks, on the other hand – the current inflationary pressure remains elevated. In combination, this situation could increase the risks of recession in the global economy,” Nabiullina did not rule out.

The Chairman of the State Duma Vyacheslav Volodin expressed a similar point of view. In his opinion the mistakes of the US government in the economic sphere provoke the emergence of the global financial crisis. The parliamentarian believes that the problems of the American financial system will most of all affect those who rely solely on it.

“The victims of the recent bankruptcies have already become ordinary citizens of other countries. We are talking about pension funds in Sweden, Norway, South Korea (invested in the shares of collapsed American banks – ). No one is going to pay them back. The United States will continue to live at the expense of others. The problems will grow and go beyond U.S. borders. The only way to protect ourselves from the crisis is dedollarization of economies,” Volodin wrote in his Telegram channel.

However, the situation in the U.S. has no direct impact on Russia, believes Elvira Nabiullina. According to her, banks in Russia do not have “such accumulated risks” on their balance sheets as financial institutions in the US and the EU do. In addition, the Russian banking sector is much less connected with the global financial system, which provides it with additional protection. A similar point of view is held by Vladislav Antonov.

“The Russian banking system is under tough sanctions of the West, so it is not so much affected by problems from outside. You can even say thank you to Western politicians that they do more damage to themselves than to Russia. There are difficulties, but all issues are solvable. The main part of settlements with trade partners is already made in national currencies,” Antonov concluded.

Leave a comment

Leave a Reply

Your email address will not be published. Required fields are marked *

Related Articles

Business

When you’re poor, you learn who your friends are. My friend Liz

Photo by Ben White on Unsplash No car means no work. I...

Business

Following the changes to Brexit, Barclays Bank made my £350,000 unattainable

Photo by Alicja Ziajowska on Unsplash I have had a Barclays bank...

Business

Save money with products that are useful for the home and garden indoors and out

Photo by Alexander Mils on Unsplash Traditionally, Britons have bought dedicated garden...