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The Fed Raises Rates Again — Will This Be the Last? 

The Federal Reserve declared a quarter-point increase in the federal funds rate on Wednesday, which has now set the target range at 5% to 5.25%. This marks the 10th successive rate increase by the central bank, and there are indications from numerous analysts that this may be the last rate hike before a significant break. 

The primary means by which the Federal Reserve maintains a robust U.S. economy is through the use of the federal funds rate, which establishes the cost for banks to borrow from one another. An increase in this rate results in higher borrowing costs, and ultimately consumers may face elevated interest rates on products such as credit cards as banks pass on those additional expenses. Correspondingly, mortgage rates and auto loan rates have a tendency to rise in conjunction with the federal funds rate. 

Federal Funds Rate:

Since March 2022, the Federal Reserve has increased interest rates, causing mortgage rates to double and elevating borrowing costs for auto loans, credit cards, and business loans. This has led to a plunge in home sales and raised the risk of a recession. The Fed’s latest decision to raise its benchmark rate to around 5.1% could further increase borrowing costs. 

Despite the rate hikes, the Fed stated in a news conference that it doesn’t think it has sufficiently cooled the economy, job market, and inflation, which remains well above its 2% target rate. The three banks that recently collapsed had purchased long-term bonds that lost value as the Fed raised rates, leading to tighter credit for mid-sized banks and an estimated “mild recession” later this year. Many economists expect the Fed to keep its benchmark rate at its peak through year-end. 

Fed Raises Rates Again

Additionally, the Fed is dealing with a standoff over the nation’s borrowing limit, which Congressional Republicans want to lift in exchange for steep spending cuts. Treasury Secretary Janet Yellen has warned that the nation could default on its debt as soon as June 1, which could lead to a global financial crisis. Powell reiterated that the Fed cannot protect the economy from the potential short and long-term effects of a failure to pay bills on time. 

The economy appears to be cooling, with flat consumer spending in February and March, weakening manufacturing, and a deceleration in hiring. Goldman Sachs estimates that a widespread pullback in bank lending could cause a recession by cutting U.S. growth by 0.4 percentage point this year. The Fed’s latest rate hike comes as other major central banks are also tightening credit, and core inflation remains chronically high at 4.6% in March. 

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Will the Fed pause rate hikes for 2023? 

The Federal Reserve has been aggressively increasing interest rates over the past year to manage inflation, which reached historic highs last summer. However, with the possibility of a recession and concerns among investors about instability in the banking system, many experts believe that further rate hikes are unlikely. 

Fed Chair Jerome Powell indicated in March that a “credit crunch” resulting from bank stress could lead to a pause in rate hikes earlier than anticipated. The Federal Open Market Committee acknowledged in its Wednesday statement that while the banking system is generally strong and resilient, tight credit conditions caused by stress in the sector could negatively impact economic activity, employment, and inflation. 


What are the chances of the Fed cutting rates? 

Although most experts agree that Wednesday’s interest rate hike will be the last for some time, there is a split among Wall Street investors regarding what will happen next. While some predict that the Fed will lower rates later this year, others believe it is premature to make such a call. 

While inflation is showing signs of cooling down, it is still a way off from being fully under control. The FOMC also shares this view, noting in its statement that it remains vigilant about inflation risks. 

Gargi Chaudhuri, head of iShares Investment Strategy, Americas, stated in an email commentary that although inflation is easing, it is not disappearing entirely, leading to the belief that interest rates will stay elevated for a longer period of time. 

However, the Fed’s plans are not set in stone and could change due to economic conditions. Chairman Powell noted in a press conference that a decision on a pause was not made at the time and that the determination would come in June. The central bank’s future policy decisions will depend on how events unfold, and they are prepared to take further action if needed. 

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What exactly is a Credit Crunch? 

According to the Federal Reserve’s economists, a credit crunch involves a significant deterioration in the availability of credit to both businesses and consumers. This means that when they need loans, they won’t be able to get them, potentially causing a slowdown in the economy or even a recession. 

Recent data shows that lending standards have been tightening since the third quarter of 2022, making it harder for consumers to access credit. Banks have been struggling to compete with the higher returns offered by money market funds and treasury bills, leading to lower deposits and tighter lending. The recent banking failures have accelerated the trend, causing a flow of deposits out of the banking system into other types of investments.  

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The Fed’s upcoming survey of loan officers should provide more insight into how banks are responding to the recent failures, but current data suggests a significant decline in bank lending, which Torsten Slok, the chief economist at Apollo, views as a clear indication of a credit crunch. This could have a negative impact on the economy as banks become more cautious about lending. 


How the Credit Crunch could affect you? 

A credit crunch makes it difficult to obtain loans, credit cards, and mortgages as banks and other lenders become more selective in deciding who they lend money to. Borrowers may face higher credit score requirements and interest rates.  

Raymond James’ Watsek suggests avoiding large loans during a credit crunch and preserving liquidity by having cash on hand, such as an emergency savings fund. Maintaining a high credit score is also crucial for borrowers to rank high when lenders are ready to lend. However, a credit crunch could benefit those with ample savings, as they can earn higher interest rates on their savings.

Some banks are offering high interest rates to attract depositors back. The effects of a credit crunch vary depending on individual circumstances. While some may benefit from better interest rates, those who require credit may face more challenges. Nonetheless, it is essential not to panic as credit crunches are temporary. 

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