The Fed announced last Wednesday that it will increase its Fed funds target by another 25 basis points, bringing it to 4.75%-5%, and indicated that another 25 bp is possible at its meeting in May. Its assurances on the stability of the banking system were not well received.
- The more “dovish” action by the Fed last week reflected its view that the likely impact of the banking sector disruptions will be “tighter credit conditions for households and businesses” and “weigh on economic activity, hiring and inflation.”
- The FOMC’s March update to its Summary of Economic Projections didn’t change its 2023 year-end fed funds rate 5.1% target, implying one more ¼% increase, and made only minor adjustments to the other economic indicators.
- Chair Powell confirmed the FOMC considered a pause in tightening, but advised that concerns about the banking sector were offset by recent economic and inflation data.
- Other segments of the U.S. economy seem to be doing better. Housing is showing both new and existing home sales climbing for several months in a row as low inventories and falling rates lead to declining mortgage rates and an almost immediate pickup in applications.
A major concern about the outflow of deposits from smaller banks, because of rising interest rates, is that it leads to tightening credit conditions and less bank lending in particular for commercial real estate.
- Since the Fed started raising interest rates 12 months ago, demand and other liquid deposits have declined by $844 billion as money flowed into small time deposits, money market funds, and bonds, with a disproportionately larger volume coming out of smaller banks in the past two weeks.
- Commercial real estate loans account for 43% of small bank loans outstanding. The $1.9trn in commercial real estate loans outstanding in small banks is more than double the $0.9trn extended by the big banks.
- If stresses on small banks cause them to reduce lending in a way that triggers an increase in commercial real estate loan defaults, it could create a broader problem for commercial real estate and bank loan portfolios.
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