Fed Raises Rates but Nods to Greater Uncertainty after Banking Stress

Officials voted unanimously to increase their benchmark short-term rate by a quarter percentage point

The Federal Reserve approved another quarter-percentage-point interest-rate increase but signaled that banking-system turmoil might end its rate-rise campaign sooner than seemed likely two weeks ago.

The decision Wednesday marked the Fed’s ninth consecutive rate increase aimed at battling inflation over the past year. It will bring its benchmark federal-funds rate to a range between 4.75% and 5%, the highest level since September 2007.

Fed Chair Jerome Powell said officials had considered skipping a rate hike after banking stress intensified last week. And he hinted that Wednesday’s increase could be their last one for now depending on the extent of any lending pullback that follows a bank run earlier this month. Regulators shuttered Silicon Valley Bank and a second institution, Signature Bank, two weeks ago, and bailed out uninsured depositors to stave off a panic.

Estimates of just how much any credit contraction could reduce hiring, economic activity and inflation were “rule-of-thumb guesswork, almost, at this point. But we think it’s potentially quite real, and that argues for being alert as we go forward,” Mr. Powell said at a news conference after the Fed’s policy meeting. Later, he said, “it could easily have a significant macroeconomic effect.”

Stocks initially rose after the Fed announcement, but then slumped on Wednesday afternoon. Mr. Powell spoke at the same time Treasury Secretary Janet Yellen told lawmakers she wasn’t considering ways to provide broad guarantees to uninsured bank deposits. The S&P 500 lost 65.90, or 1.6%, to end at 3936.97. Yields on the 10-year Treasury note fell 0.106 percentage points, closing at 3.497%.

All 11 voters on the rate-setting Federal Open Market Committee agreed to the rate hike.

New projections showed almost all 18 officials who participated in the meeting expect the fed-funds rate to rise to at least 5.1%, implying one more quarter-point increase and no rate cuts this year. The quarterly projections were little changed from those released in December.

Mr. Powell said officials intended their postmeeting policy statement to suggest greater uncertainty about future rate rises. Since they began lifting borrowing costs one year ago, the statement had said they anticipated “ongoing increases” in rates. But Wednesday’s statement said, “Some additional policy firming may be appropriate.”

Mr. Powell “opened the door to the possibility that this was the last rate increase,” said Marc Sumerlin, a former economic adviser to President George W. Bush.

Fed officials have at times over the past year acknowledged the risk of being forced to simultaneously fight two problems—financial instability and inflation. Several have said they would use emergency lending tools, along the lines of those unveiled this month, to stabilize credit markets so the Fed could continue to raise interest rates or hold rates at higher levels to combat inflation.

The recent bank turmoil offers the strongest evidence yet of spillovers from higher interest rates to the broader economy. The upheaval has served as a stiff reminder of the perils Fed officials, regulators, lawmakers and the White House face trying to corral inflation that soared to a 40-year high last year.

U.S. policy makers cushioned the economic shock created by the Covid-19 pandemic in 2020 and 2021 by providing extensive financial aid and cheap money. Congress and the White House have largely delegated to the Fed the task of taming price pressures.

The fed-funds rate influences other borrowing costs throughout the economy, including rates on mortgages, credit cards and auto loans. The Fed has been raising rates to cool inflation by slowing economic growth. It believes those policy moves work through markets by tightening financial conditions, such as by raising borrowing costs or lowering prices of stocks and other assets.

Mr. Powell said Wednesday that it was possible banking turmoil would further tighten conditions, meaning there could be less of a need for the Fed to raise rates.

Since officials’ previous meeting, Jan. 31-Feb. 1, the economy had shown surprising strength, leading to concerns that aggressive rate rises over the previous year hadn’t done enough to slow the economy and lower inflation. Central bankers are concerned that prices will keep rising steadily if consumers and businesses expect them to.

Two weeks ago, Mr. Powell suggested officials would debate whether to raise rates by a quarter-point or a bigger half-point after reports showed hiring, spending and inflation were stronger early this year than they thought at the time of their most recent meeting.

An astonishing run on the $200 billion Silicon Valley Bank changed everything. SVB’s depositors were heavily concentrated in the tightknit world of venture capital and startup firms, which were burning cash and withdrawing deposits as the once-highflying technology sector cooled.

On March 8, SVB said it was looking to raise capital from investors and that it would record a loss on longer-dated securities whose values had fallen as interest rates shot up. Nearly a quarter of the bank’s deposits fled over the next day and the bank was taken over by regulators on March 10.

“At a basic level, Silicon Valley Bank management failed badly,” said Mr. Powell. He didn’t say why bank supervisors at the San Francisco Fed or regulators in Washington hadn’t forced the bank to correct deficiencies in time, referring to the Fed’s previously announced internal audit that will be made public by May 1.

The Fed has sharply boosted lending to banks, including through a new facility with more generous terms, to ease fears of broader contagion. Still, banking-sector tremors are likely to lead to a pullback in lending because banks will face increased scrutiny from bank examiners and their own management teams to reduce risk taking.

Banks could also see earnings squeezed if they feel pressure to raise deposit rates, which could further crimp lending. The failure of SVB could provide a catalyst for more consumers and businesses to move money out of lower-yielding bank accounts and into higher-yielding money-market funds. While money-market mutual funds have been offering interest rates close to 4.5% as the Fed has raised short-term rates rapidly, the national average savings deposit rate stood at less than 0.3% last week, according to Bankrate.com.

The Fed’s emergency lending authorities can address liquidity strains, or the ability to get cash to where it is needed in the financial system. But those tools can’t solve more fundamental business challenges caused by a potential end to low bank deposit rates, for example.

“I think we’re looking at a sizable credit crunch,” said Daleep Singh, a former executive at the New York Fed who is now chief global economist at PGIM Fixed Income.

Economists said the Fed’s own forecasts and Mr. Powell’s comments appeared to reflect similar concerns. Officials could have downplayed the fallout from SVB’s collapse as an idiosyncratic episode caused by a poorly managed bank, but “they didn’t brush it under the carpet,” said Priya Misra, head of interest-rate strategy at TD Securities.

Banking stress had led to questions in the past week over whether the Fed would even raise rates at all, particularly before Swiss authorities on Sunday arranged a forced marriage of banking giants UBS Group AG and Credit Suisse Group AG.

Some analysts said the Fed would have been hard-pressed not to raise interest rates given the economy’s recent strength and aggressive measures taken to shore up confidence in the banking system.

“Right now pausing would cause disruption,” said Donald Kohn, a former Fed vice chair. Deciding against raising rates would “signal that they don’t have confidence in their financial stability tools.”

Others disagreed. It would have been better for the Fed to move cautiously by deferring a possible increase until the central bank’s next meeting, in early May, given the fragile financial backdrop, said Jan Hatzius, chief economist at Goldman Sachs. “If more issues crop up after Wednesday, that’s also not going to be very confidence inspiring,” he said.