Bank failures add to uncertain future for US economy

WASHINGTON (TND) — The U.S. economy that has withstood aggressive interest rate hikes, an oil shock from the war in Ukraine, a labor shortage and stubborn inflation is still facing an uncertain future coming out of the coronavirus pandemic.

A strong labor market and signs of slowing inflation have kept the U.S. from falling into a recession despite the Federal Reserve increasing its interest rates at a historically fast pace over the last year to cool the economy.

The Fed is trying to navigate a tight line of cooling inflation without tipping to economy into recession and achieving a soft landing. So far, the economy has been able to weather the rapid rate hikes and inflation is down from record highs seen last summer, though is still triple the central bank’s goal of 2%.

Wage gains have slowed over the last several months and unemployment — while still low compared to historical standards — has inched up as more people enter the labor market. Officials at the Fed have said they want to see cooling in the labor market before they are ready to declare inflation to be in definite decline.

“While there is still some uncertainty, it seems like things are generally heading in a positive direction compared to where we were before,” said Jadrian Wooten, collegiate associate professor of economics at Virginia Tech. “It appears that the biggest financial stability problems have been resolved and discussions about the debt limit are moving in a positive direction. While it's easy to be pessimistic about any one of these things, overall, it seems like we are moving in the right direction.”

The unexpected collapse of two banks over the weekend has added to the unknown as the federal government has scrambled to create a backstop against further bank runs and tried to reassure consumers that their money is safe in the U.S. banking system.

The downfall of Silicon Valley Bank and Signature Bank have rattled Wall Street, with shares of other regional banks down so far this week and raising questions about how Americans will respond.

Losses have been concentrated in small and mid-size banks, which face the greatest risk of bank runs where customers would rush to withdraw their money and move it into larger financial institutions they consider to be “too big to fail.”

Officials at the Treasury Department and Fed are closely monitoring the country’s banks and have already taken steps to avoid more bank runs. All deposits at SVB and Signature have been guaranteed and the Fed has created a fund offering other banks loans on generous terms to help provide liquidity in the event they run into issues with customers withdrawing funds.

Analysts and investors are also expecting the collapses to force the Fed to reconsider its plans regarding its next interest rate hike during the next Federal Open Markets Committee meeting on March 22.

Fed chairman Jerome Powell’s testimony before Congress set expectations the FOMC would go with a 50-point increase as inflation and the labor market remain hotter than the central bank would like to see.

The Department of Labor's reading of consumer prices in February fell to an annual rate of 6%, down from January's reading of 6.4%. On Tuesday, investors were predicting a 25-point increase with a roughly 30% of no increase at all.

“One reason the Federal Reserve is gradually raising interest rates over an extended period of time is due to the current uncertainty in the economy. This approach allows for a more controlled and transparent process, where everyone is aware of what's happening, and adjustments can be made if the situation becomes too risky,” Wooten said. “It would be more worrisome if the Fed were overly confident during a time of such uncertainty and raised rates quickly. Chairman Powell's cautious approach is reassuring to investors, and has at least been willing to acknowledge the uncertainty and proceed with caution.”

What comes next is another factor of uncertainty playing out over a fragile economy and marketplace that has been more volatile since the collapse of the banks.

“In the short run, this change is not likely to have a significant impact as analysts had already assumed more caution following the bank’s collapse,” Wooten said. “This is positive news, as much of the current uncertainty is already reflected in current interest rates. If the Fed decides to make no changes or less dramatic ones, it is expected that interest rates will remain stable because market participants will anticipate future changes.”

Also looming over the economy is the ongoing fight on Capitol Hill over raising the U.S. debt limit with little movement from either side. Republicans in control of the House are pushing the White House to agree to spending cuts in exchange for raising the debt limit, while President Joe Biden has said he will not negotiate and called for a clean increase, arguing that the debt limit is to pay for past spending bills, some of which were enacted under Republicans during the Trump administration.

Economists have warned of grave consequences for the economy if lawmakers do not reach a solution by the time the U.S. is no longer able to pay its bills through a series of accounting maneuvers from the Treasury Department to avoid a default.

The U.S. hit the $31.4 trillion limit in January and will be able to operate into the summer without an increase. When the “X-date” of the accounting maneuvers no longer being able to stave of default is reached, the country’s economy could spiral quickly. Outside analyses of when the X-date will be reached vary from June to August.