Inflation in the US Persistent, and a New Headache for the Fed is the Banking Horror in Silicon Valley

Inflation in the US has remained sufficiently present to further complicate the work of the Federal Reserve, which is grappling with the bankruptcy of three banks and broader concerns for financial stability.

The Consumer Price Index rose six percent year-on-year in February, following a 0.4 percent increase from the previous month. This is a step below the annual rate of 6.4 percent recorded in January, although it is still elevated.

Excluding volatile food and energy prices, the ‘core’ CPI rose an additional 0.5 percent in February, compared to last month’s increase of 0.4 percent and above economists’ expectations. Year-on-year, it increased by 5.5 percent, just 0.1 percentage points lower than January’s year-on-year rate, reported the Financial Times.

Data released on Tuesday by the Bureau of Labor Statistics comes at an awkward time for the Fed, which was forced to step in on Sunday night to contain the fallout from the sudden collapse of Silicon Valley Bank (SVB) on Friday. A few days earlier, the crypto bank Silvergate also closed its doors.

Falling Stocks of Regional Banks

After a turbulent weekend during which no buyer emerged to take over the besieged tech lender, which was at that point taken over by the Federal Deposit Insurance Corporation, authorities rushed to assemble a rescue package before the opening of Asian markets on Monday.

Not only are deposits fully guaranteed for account holders at SVB and Signature Bank, another lender that regulators shut down on Sunday, but the central bank introduced a new lending mechanism to ensure that ‘banks have the ability to meet the needs of all their depositors.’

The so-called Bank Term Funding Program, which is backed by $25 billion from the US Treasury, offers loans of up to one year to lenders who pledge collateral, including US Treasury bonds and other ‘qualifying assets,’ which will be valued at face value, FT reported.

Despite these measures, shares of First Republic and other regional banks considered vulnerable after the collapse of SVB sharply fell on Monday.

In this context, investors and economists quickly changed their views on the path forward for the Fed, which had toyed with the idea of accelerating the pace of its interest rate hikes last week and opted for a half-point increase at its meeting from March 21 to 22.

After the banks’ bankruptcies, Wall Street is divided over whether the Fed will proceed with another quarter-point rate hike or completely abandon an increase. Expectations for the terminal rate, which at one point exceeded 5.5 percent, have also been revised lower.

Following the inflation data for February, investors confirmed bets that the Fed would opt for a quarter-point rate increase. The reaction of financial markets was otherwise muted. Approximately 70 percent of the overall inflation increase stems from housing-related costs, which rose by 0.8 percent between January and last month. Compared to the same period last year, they are up by 8.1 percent.

Officials said they are looking beyond that, however, as the so-called ‘shelter’ metric tends to lag behind the data by several months. Home prices have begun to decline nationally, and rents have decreased, suggesting that this component of the inflation report will soon reverse.

Interest Rates from Zero to Nearly Five Percent

What is even more concerning is that service-related costs were elevated in February, including a 1.1 percent increase in transportation costs for this month. This is a 14.6 percent increase year-on-year. Prices for recreation also rose along with those for furniture and new cars, while used cars continued to see slowed price growth.

Speaking before Congress earlier this month, prior to the banking collapse, Federal Reserve Chairman Jay Powell said that the Fed would respond more aggressively to raising rates if the data indicated a sustainable recovery in economic momentum. He also warned at that time that the endpoint of the Fed’s tightening campaign, known as the terminal rate, would likely need to be higher than the 5.1 percent level that most officials had set at the end of 2022.

The inflation report was the latest in a series of important data releases. Powell said he would monitor the situation to determine the size of the next interest rate increase. The second was the jobs report for February, which showed that employers added 311,000 jobs last month, a slower pace than previous declines, but still significantly above what officials indicate is consistent with easing price pressures.

The Fed had already reduced the pace of its tightening in February to a more traditional quarter-point pace, following multiple half-point and three-quarter-point moves last year.

In just one year, the central bank has raised its benchmark interest rate from nearly zero to almost 4.75 percent – a historically aggressive pace that some believe has also partially contributed to the collapse of SVB given its holdings of long-term fixed-rate bonds and lack of protection against rising rates, FT reported.