[Global Focus] One Year of US Interest Rate Hikes, Powell at a Crossroads

by Kwon Haeyoung

Published 11 Apr.2023 07:16(KST)

Updated 20 Dec.2023 14:04(KST)

Start of War Against Inflation in March Last Year
Base Interest Rate Raised from 0.25% to 5.0%
Inflation Reduced to 6% Range but Inflation Risks Persist
High-Intensity Tightening Leads to SVB Bankruptcy-Induced Banking Crisis
Central Banks Worldwide Begin Decoupling

[Global Focus] One Year of US Interest Rate Hikes, Powell at a Crossroads

It has been one year since the United States began its high-intensity tightening policy. The U.S. Federal Reserve (Fed) raised interest rates a total of nine times over the past year, starting in March last year, increasing the benchmark rate from 0.25% to 5.0%. The goal was to reduce inflation comparable to the oil shock of the 1980s.

The scars from the relay of rate hikes were significant. As major countries followed the Fed's rate increases, the interest burden on households and businesses worldwide intensified. The market dried up, and the crisis that began with the bankruptcy of Silicon Valley Bank (SVB) in the U.S. spread to Switzerland's Credit Suisse (CS), leading to a global financial sector collapse fear cycle known as the "Bankdemic" (bank + pandemic).

Even amid these aftershocks of tightening, inflation remains sticky, and the labor market is still robust. There is an assessment that Fed Chair Jerome Powell is struggling with whether to continue his role as an 'inflation fighter' between inflation and the Bankdemic.

U.S. Raises Rates 9 Times in One Year... Inflation Drops from 9% to 6%

The curtain rose on the global rate hike with the Fed's 0.25 percentage point increase on March 16 last year (local time), the first in 3 years and 3 months as announced. Over the year, rate hikes totaling 4.75 percentage points were implemented. The war against inflation has been ongoing for a year.

The effects of the long and deep tightening are gradually appearing. The U.S. consumer price index dropped from 9.1% in June last year to 6.0% in February this year. It is expected to fall to the 5% range in March (Cleveland Federal Reserve Bank forecast: 5.22%). The previously strong employment is also showing signs of slowing. Nonfarm payrolls in March were 236,000, lower than January (472,000) and February (326,000). It also decreased compared to the six-month average (334,000).

However, this level is insufficient to declare victory. The personal consumption expenditures (PCE) price index, closely watched by the Fed, was 5% in February, barely matching the policy rate level. It remains higher than the target (2%). Although nonfarm payrolls have slowed, they are still higher than the pre-COVID-19 average (around 220,000). The unemployment rate in March fell to 3.5%, down from 3.6% the previous month.

It is difficult to say that the inflation fire has been completely extinguished. Although it seems the tightening phase has reached its end, the Fed is at a crossroads, debating whether to create a turning point in interest rates here. James Bullard, President of the St. Louis Federal Reserve Bank and a prominent hawk over the past year, explained, "If the labor market is strong, rate hikes are necessary," adding, "The Fed will need to raise rates a few more times."

What Comes After the SVB Incident

However, continuing the current tightening is also burdensome. The aftereffects of tightening are scarring the market.

The shock of rate hikes manifested last month in the unexpected bank crisis triggered by SVB's bankruptcy. As interest rates rose, companies facing higher funding costs withdrew deposits, and SVB used funds raised by selling U.S. Treasury bonds to return deposits. However, news that SVB was forced to sell Treasury bonds at a loss due to falling bond prices moving inversely to interest rates triggered a bank run (massive deposit withdrawals), ultimately leading to the bank's collapse. As a result, Europe's Credit Suisse was sold to UBS, disappearing into history after 167 years.

Earlier this year, the U.S. was discussing a no-landing scenario, where inflation could be reduced without a recession. But the SVB incident left the saying "there is no painless tightening" as a lesson and marked a turning point to another phase. Bloomberg pointed out, "The Fed is not good at changing monetary policy without major shocks," calling the SVB incident "Exhibit A."

There are also comparisons to the era of Paul Volcker, Fed Chair known as the 'inflation killer.' In early 1976, U.S. inflation was below 5%, but it surged to 11% by 1979. Volcker, who took office in 1979, raised the benchmark interest rate from 11% to 19% within two years by 1981. The recession caused many companies to go bankrupt, and unemployment soared to 10%. Rapid rate hikes led to the closure of about 3,000 savings and loan associations (S&Ls) and small to medium-sized banks. Volcker brought inflation down to the 4% range by the end of 1982, but the cost was severe.

The market is concerned about where the Bankdemic will spread next. There are worries that the U.S. commercial real estate market, with $1.5 trillion (about 2,000 trillion KRW) in loan maturities due by 2025, could become a bomb. The market has dropped nearly 40% from its peak, and if small and medium-sized banks tighten lending regulations due to this incident, credit tightening could worsen.

Central Banks of Various Countries ‘Decoupling’

Countries that raised rates following the U.S. are now seeking their own paths. The Reserve Bank of Australia held its benchmark rate steady at 3.6% on the 4th. It stopped the 10 consecutive rate hikes that began in May last year. Canada (March), Indonesia (February), and Malaysia (January) also halted rate hikes this year. South Korea, after a year of consecutive rate hikes, froze its benchmark rate at 3.5% last month and is likely to maintain the current rate on the 11th as well.

Until early this year, these banks tried to control domestic inflation while preventing currency depreciation and capital outflows caused by the U.S.'s high-intensity tightening and strong dollar. However, due to differing economic strengths and worsening funding difficulties for households and businesses, which hamper growth, they have taken a 'every man for himself' approach within a year. There are also forecasts that more emerging countries will cut benchmark rates within the year. U.S. investment bank JP Morgan expects five countries?Hungary, Chile, Peru, Czech Republic, and Colombia?to lower rates in the second to third quarters.

Fed at a Crossroads

[Image source=Yonhap News]

The future direction of interest rates is shrouded in fog. With Chair Powell walking the path of former Fed Chair Paul Volcker, who tamed inflation in the 1980s, the unexpected Bankdemic has brought the Fed to a crossroads: whether to continue or halt rate hikes. CNBC diagnosed that as the Fed wrestles with high inflation and a banking crisis emerges, questions arise about future policy direction and its repercussions.