Fed May Pause Rate Hikes in the Face of Slow Lending

There is still a high likelihood that the Federal Reserve will raise interest rates at their next meeting on May 2-3, however, key data between now and then, particularly a survey of bank lending officers, may have an impact on how they decide whether to pause further increases and how they weigh the risks facing the U.S. economy.

‍

Having met with bank executives and contacts in other industries on March 21-22, Fed officials say they have been in constant contact since then to gauge how the dramatic collapse of Silicon Valley Bank on March 10 has affected the willingness of financial firms to provide credit to businesses and households and to assess whether bigger problems might arise.

‍

Fed officials said that increased monitoring of liquidity has included daily checks on all banks' liquidity as well as ensuring that they have the documentation ready to borrow as quickly as possible from different Fed facilities should it be necessary - a sign that top central bankers were seriously concerned about the collapse of Signature Bank and SVB.

‍

Although there has been a muted impact since then, Fed officials have shifted their focus back to persistently high inflation and the need for at least one more quarter-point increase in interest rates in their final comments before the pre-meeting blackout begins on Saturday, when the fallout is expected to be muted enough.

‍

There was an overall decline in bank credit of around 1.5% over the three weeks from Wednesday, March 15 to Wednesday, April 5, and there were initial outflows of deposits from smaller banks to larger ones in those three weeks. This was quickly reversed, and the Fed's recent Beige Book compilation of observations about the economy showed the lending impact was seemingly regionalized and had not developed into an imminent national credit crisis.

‍

"There was some turbulence...but some of it sort of worked itself out," Atlanta Fed President Raphael Bostic said in an interview with Reuters in the aftermath of the collapse of the SVB." A number of questions were asked by our team of bankers. Have you seen deposits leave the bank? Are you receiving heightened calls?... There was a heightened alert."

‍

Bostic, however, noted that when he asked the staff if they had heard anything out of the ordinary, they responded with a firm "No, we really haven't."

‍

Recent weeks have seen similar comments from throughout the Fed system, with a sense of apprehension and increased information flow followed by a sense that the worst problems seem to have been avoided, as well as a sense that the worst problems do not appear to have occurred.

‍

Consequently, investors in federal funds futures have followed this trend by raising their expectations that the U.S. central bank will follow through with its tenth consecutive hike in interest rates. It is expected that the federal funds rate is to rise by a quarter point at the May meeting, meaning that the interest rate would be raised to the range of between 5% and 5.25% that the Federal Reserve policymakers had projected for the current round of policy tightening in both December and March.

‍

In addition, investors in the market are betting, in large part, that the Fed's next rate hike will be the last one, despite a complicated situation in which some of the key information on the topic of the Fed's discussion will not be available to the public until after the meeting.

‍

A number of headline data points have emerged since the Fed's last meeting, which points to the development of an economic slowdown and gives reason to expect inflation to slow. It was indeed predicted that a "mild recession" would begin later this year by some of the Fed Board of Governors staff at the April meeting of the Federal Open Market Committee.

‍

In the meantime, hiring continued to be strong throughout March, and wages continued their rapid growth at a quicker pace than Fed officials felt was sustainable. This is the case across important sectors of the service industry as well, with inflation so persistent that one of the most influential policymakers, Fed Governor Christopher Waller, heads into the meeting with an opinion that progress on inflation has "more or less stalled."

‍

A new set of data on the Personal Consumption Expenditures price index, which is used as the basis for setting the Fed's 2% inflation target, will be obtained by next Friday. There was a 5% annualized increase in PCE inflation as of February.

‍

On the same day, an updated Employment Cost Index will be released, providing a broader perspective on the cost of labor for employers as well. There is only one release of the Employment Cost Index every quarter, and it includes both employee pay and benefits such as healthcare, giving what the Federal Reserve officials regard as a better picture of how labor-related costs are trending.

‍

Among the most important information that will be presented at the upcoming Federal Open Market Committee meeting will be the results of the Senior Loan Officer Opinion Survey, a questionnaire that is sent to a sample of U.S. banks every three months, with the results presented at each other meeting.

‍

The SLOOS report will be released to the public about a week after the Fed convenes, which means that the markets and investors will not be able to process it in advance, unlike most other economic data relevant to the central bank's decisions.

‍

While SLOOS is mainly qualitative information, it is widely considered to be one of the best indicators of lending trends since it asks whether banks are tightening or loosening their loan standards.

‍

This could also have an impact on Fed officials' perception of whether the economy and inflation are likely to slow down more quickly - or even much more quickly - than they anticipated. In turn, this will shape views about whether interest rates will be held steady after the next rate hike or whether they will have to rise further. Moreover, that outlook will shape how the Fed describes its outlook in its policy statement, which currently states "some additional policy firming is likely to be required".

‍

It was the Fed's last SLOOS survey that was presented at the Fed's Jan. 31-Feb. In a meeting held by the Fed a week ago, and released about a week later, loan officers were reporting tightening conditions, but in their presentation of the results, Fed staff pointed out that some key types of credit to businesses and households continued to expand.

‍

A survey expected to be released this week is expected to show conditions tightening even further, alongside data showing banks' credit growth is contracting, according to economists.

‍

A major challenge for the Fed will be determining if all of that is just the expected impact of rate hikes reaching record levels for the first time, or if there is something else going on that goes beyond what is needed to control inflation.

‍

Oxford Economics Chief U.S. Economist Ryan Sweet wrote in a recent article that, while a broad banking crisis may have been avoided, the focus now is on the severity of the tightening of lending standards that were seen in the SLOOS.

‍

"As per the last survey, it already appears that business investment will fall later this year, and "the risks continue to point in the direction of a larger hit to gross domestic product," he pointed out. "There is a possibility that banks aren't done tightening lending standards, which will restrict access to credit, hurt business investment, reduce the formation of new companies, and weigh on job growth and consumer spending."