Friday's Market Minute: The Fed Raises Rates While The Regional Bank Fallout Continues

The FOMC followed through this week with the tenth straight interest rate hike, totaling a monumental 500 basis points in a little over a year. The Fed funds rate has not been this high since mid-2007, and elevated inflation continues to restrain the Fed from easing any time soon. Coincidently, the unemployment rate is actually lower today than when the tightening cycle began. Unless unemployment rises and recession occurs, the Fed is unlikely to relinquish their hawkish stance.

The economy slowed in the first quarter, but inflation accelerated slightly as measured by the core Personal Consumption Expenditures price index, which printed 4.9% on an annualized pace in the quarter. Powell acknowledged that it is possible that we’ll have what would be a mild recession and that they will closely monitor incoming information in determining the extent to which additional policy firming may be appropriate to return inflation to 2% over time. In a nutshell, it appears the Fed will pause the rate hike campaign based upon current and forward-looking economic conditions. Despite the aggressive pace and magnitude of the rate hikes, the policy interest rate measured against inflation is now in a neutral position.

Complicating matters for the Fed, many regional bank stocks remain in turmoil with the potential of tighter lending conditions at a time when private sector fixed-investment spending is in high demand to sustain a tight labor market with elevated inflation pressures. Specific regional bank failures may further constrict credit beyond the Fed’s traditional monetary policy tools. However, the failures appear to remain contained to those that have the least balance sheet flexibility to sustain deposit flight, were reluctant to hedge long-duration interest rate risk, or have asset-to-liability mismatches that have equity holders running for cover.

Banks such as Pacific West (PACW) and Western Alliance (WAL) continue to trade poorly and make cause for concern. Disregarding a handful of weaker financial intuitions, the disparity in equity performance between at-risk regional banks and larger money center commercial banks does not suggest systemic financial stability is an imminent concern. The market could simply be indicating that there are too many banks in competition with each other and the weaker names simply don’t have the longevity to survive against the too big to fail economies of scale.

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