"Should Interest Rate Hikes Stop? SVB Bankruptcy Adds New Variable to Fed's Tightening Path"

The sudden collapse of Silicon Valley Bank (SVB) in the United States has emerged as a new variable in the Federal Reserve's (Fed) interest rate hike trajectory. It has been confirmed that the rapid tightening since last year dealt a direct blow to the asset soundness of banks, including SVB. Amid growing uncertainty, some voices are even warning that the Fed should temporarily halt interest rate hikes.

Ed Hyman, Chairman of Evercore ISI, mentioned the recent SVB collapse in an investor memo on the 12th (local time), stating, "Considering the financial shock, it might be a good idea for the Fed to temporarily pause (interest rate hikes)," adding, "If inflation accelerates after the Fed pauses, it can easily tighten again." This claim comes ahead of the March Federal Open Market Committee (FOMC) meeting scheduled for the 21st-22nd, amid increased financial market instability due to the SVB collapse.

Initially, the market widely expected that the Fed might accelerate the rate hike to a big step (a 0.5 percentage point increase in the benchmark interest rate) at this month's FOMC. This was because inflation showed little sign of easing, and employment, price, and consumption indicators released since the beginning of the year all exceeded expectations. Accordingly, Fed Chair Jerome Powell hinted at the possibility of a big step last week, saying, "We are ready to increase the pace of rate hikes."

However, the SVB incident that broke out in the latter part of the week after Powell's remarks confirmed that rapid interest rate hikes are impacting not only the real economy but also the financial system. This has strengthened arguments that it may not be easy for the Fed to return to big step hikes. Mohamed El-Erian, Senior Advisor at Allianz, pointed out that this incident "shows that even small banks in a narrow sense can pose systemic risks," and "in a broader sense, this is the trilemma of the ongoing monetary policy changes." Larry McDonald, founder of the Bear Traps Report, predicted that the Fed could lower rates by 1.0 percentage point by December due to this incident. He criticized, "The Fed caused this bank run."

[Image source=Yonhap News]

Experts evaluate that the Fed's actions, which raised the benchmark interest rate by 4.75 percentage points over the past year, are behind the sudden collapse of SVB, which had total assets of $209 billion (277 trillion KRW). SVB, whose main clients are venture capital and startups, invested the assets and deposits accumulated during the pandemic heavily in safe assets such as U.S. Treasury bonds and government-guaranteed bonds. However, due to the Fed's high-intensity tightening starting last year, bond prices plummeted, causing massive losses. Additionally, the rising burden of deposit interest further deteriorated SVB's soundness.

Some in the market are increasingly cautious, pointing out that the essence of the SVB incident lies in the high interest rates, and that the ripple effects could spread to other banks facing similar situations in the future. Most U.S. banks hold a significant amount of bonds, including U.S. Treasury securities, as assets. Concerns are also pouring out regarding small and medium-sized regional banks exposed to real estate loans.

U.S. Treasury Secretary Janet Yellen also appeared on CBS that day and said, "The problem in the tech sector is not the core of this incident," emphasizing that the essence lies in the Fed's interest rate hikes to curb inflation. As a former Fed Chair, she said, "The Fed is independent and responsible for dealing with financial crises and determining the appropriate measures to achieve inflation and employment goals," adding, "I will not comment on what the appropriate response should be."

Ultimately, the key is expected to be the Consumer Price Index (CPI) to be released on the 14th. Wall Street estimates that the February CPI will rise 6.1% year-on-year, a slowdown from the previous month's increase of 6.4%. The core CPI, excluding volatile energy and food prices, is forecast to rise 5.5% year-on-year and 0.4% month-on-month. Along with this, the Producer Price Index (PPI) for February and retail sales will also be released this week. According to the CME FedWatch tool, the federal funds (FF) futures market currently still weighs the possibility of a big step at the March FOMC.