22nd May 2023
Hugues Chevalier, Economist
For the tenth time in just over a year, the Federal Reserve (Fed) raised its key interest rates by 25 basis points to 5%, the highest level since 2007. The continued tightening of monetary policy in the United States is the consequence, as in Europe, of persistent inflation that is well above the 2% target. In order to calm demand and price increases, the US labour market is expected to deteriorate and household consumption to slow down. While retail sales have slowed, the labour market remains buoyant with the unemployment rate still at historic lows. However, unfilled job vacancies are starting to fall, and wages are beginning to slow, which could slow the rate hike in the coming months. But at the same time, a fourth bank failure has occurred as a result of the rise in policy rates. The First Republic Bank of San Francisco failed and was taken over by the JP Morgan Group on May 1st. This is the fourth bank failure since March. Even if the management of these banks can be questioned, the rise in rates weakens the weakest regional banks, because, faced with massive withdrawals of liquidity by customers, the banks have to sell treasury bills, the prices of which have fallen sharply with the rise of interest rates and, consequently, increase their losses. Three other regional banks have been in turmoil for the past few days and fears of a major financial crisis are re-emerging. The Fed claims that the US banking system is sound. Maybe. But the Fed’s horse medicine is causing unforeseen side effects in the banking sector that could escalate.