Fed Raises Rates but Nods to Greater Uncertainty After Banking Stress | Kanebridge News
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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

Thu, Mar 23, 2023 9:07amGrey Clock 5 min

The Federal Reserve approved another quarter-percentage-point interest-rate increase but signalled 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.

Officials sent a hint that they might be done raising interest rates soon in their post meeting policy statement. “The committee anticipates that some additional policy firming may be appropriate,” the statement said. Officials dropped a phrase used in their previous eight statements that said the committee anticipated “ongoing increases” in rates would be appropriate.

The policy statement said it was too soon to tell how much recent banking stress would slow the economy. “The U.S. banking system is sound and resilient,” the statement said. “Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain.”

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

New projections showed 17 out of 18 officials who participated in the meeting expect the fed-funds rate to rise to at least 5.1% and to stay there through December, implying one more quarter-point increase. The quarterly projections were little changed from those released in December.

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 stabilise credit markets so they could continue to raise interest rates or hold rates at higher levels to combat inflation.

At a news conference after the decision, Fed Chair Jerome Powell said officials had considered holding rates steady but opted to raise them given signs of still-high inflation and economic activity.

Various estimates of how much the banking stress could slow the economy amount to “guesswork, almost, at this point,” Mr. Powell said. “But we think it’s potentially quite real. And that argues for being alert as we go forward.”

That 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.

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 Jan. 31-Feb. 1 meeting. “Nothing about the data suggests to me that we’ve tightened too much,” he said on March 7 before the Senate Banking Committee.

An astonishing run on the $200 billion Silicon Valley Bank changed everything. SVB’s depositors were heavily concentrated in the tight knit 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.

To avoid a broader panic, federal authorities guaranteed the uninsured deposits of the California lender and a second institution, New York’s Signature Bank. The Fed also began offering loans of up to one year to banks on more generous terms as a precaution.

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.

That would mean fewer loans to consumers to buy cars, boats, homes and other big-ticket items, and less credit for businesses to hire, expand or invest, raising the risk of a steeper economic downturn.

Banks with fewer than $250 billion in assets account for roughly 50% of U.S. commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending, and 45% of consumer lending, according to Goldman Sachs.

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

Since officials’ previous meeting, 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 rapidly if consumers and businesses expect them to.

Inflation fell to 4.7% in January from 5.2% in September, as measured by the 12-month change in the personal-consumption expenditures price index excluding food and energy, the Fed’s preferred gauge. Economists expect the government to report next week that the inflation rate was unchanged in February.

Banking stress had led to questions in the past week over whether the Fed would even raise rates at all.

Some analysts fretted that a timeout on rate rises would risk so-called financial dominance, in which monetary policy becomes overly focused on avoiding market stress to the detriment of fighting inflation. A big market rally, in which stock prices rise and borrowing costs fall, could spur more demand and fan price pressures.

“They’d like to avoid that,” said William English, a former senior Fed economist who is a professor at Yale School of Management.

Others said the Fed would have been hard-pressed not to raise interest rates given recent strength in the economy 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.”

Jan Hatzius, chief economist at Goldman Sachs, disagreed. It would have been better for the Fed to move cautiously given the highly uncertain environment that resulted from the banking stress, he said. “If more issues crop up after Wednesday, that’s also not going to be very confidence inspiring,” he said.

Fed officials have tried to signal their interest-rate moves deliberately over the past year to avoid the kind of market turmoil set off in 1994, when the Fed doubled its short-term benchmark rate from 3% to 6% in a 12-month span.

That rapid tightening hammered stocks and bonds and indirectly contributed to the demise of Kidder Peabody & Co., the bankruptcy of Orange County, Calif., and Mexico’s peso devaluation, which required a bailout from the U.S. and the International Monetary Fund.

After skipping on a rate increase in December 1994, as the peso crisis intensified, the Fed made a final rate increase in early 1995.


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China’s EV Juggernaut Is a Warning for the West

Competitive pressure and creativity have made Chinese-designed and -built electric cars formidable competitors

Thu, Jun 8, 2023 4 min

China rocked the auto world twice this year. First, its electric vehicles stunned Western rivals at the Shanghai auto show with their quality, features and price. Then came reports that in the first quarter of 2023 it dethroned Japan as the world’s largest auto exporter.

How is China in contention to lead the world’s most lucrative and prestigious consumer goods market, one long dominated by American, European, Japanese and South Korean nameplates? The answer is a unique combination of industrial policy, protectionism and homegrown competitive dynamism. Western policy makers and business leaders are better prepared for the first two than the third.

Start with industrial policy—the use of government resources to help favoured sectors. China has practiced industrial policy for decades. While it’s finding increased favour even in the U.S., the concept remains controversial. Governments have a poor record of identifying winning technologies and often end up subsidising inferior and wasteful capacity, including in China.

But in the case of EVs, Chinese industrial policy had a couple of things going for it. First, governments around the world saw climate change as an enduring threat that would require decade-long interventions to transition away from fossil fuels. China bet correctly that in transportation, the transition would favour electric vehicles.

In 2009, China started handing out generous subsidies to buyers of EVs. Public procurement of taxis and buses was targeted to electric vehicles, rechargers were subsidised, and provincial governments stumped up capital for lithium mining and refining for EV batteries. In 2020 NIO, at the time an aspiring challenger to Tesla, avoided bankruptcy thanks to a government-led bailout.

While industrial policy guaranteed a demand for EVs, protectionism ensured those EVs would be made in China, by Chinese companies. To qualify for subsidies, cars had to be domestically made, although foreign brands did qualify. They also had to have batteries made by Chinese companies, giving Chinese national champions like Contemporary Amperex Technology and BYD an advantage over then-market leaders from Japan and South Korea.

To sell in China, foreign automakers had to abide by conditions intended to upgrade the local industry’s skills. State-owned Guangzhou Automobile Group developed the manufacturing know-how necessary to become a player in EVs thanks to joint ventures with Toyota and Honda, said Gregor Sebastian, an analyst at Germany’s Mercator Institute for China Studies.

Despite all that government support, sales of EVs remained weak until 2019, when China let Tesla open a wholly owned factory in Shanghai. “It took this catalyst…to boost interest and increase the level of competitiveness of the local Chinese makers,” said Tu Le, managing director of Sino Auto Insights, a research service specialising in the Chinese auto industry.

Back in 2011 Pony Ma, the founder of Tencent, explained what set Chinese capitalism apart from its American counterpart. “In America, when you bring an idea to market you usually have several months before competition pops up, allowing you to capture significant market share,” he said, according to Fast Company, a technology magazine. “In China, you can have hundreds of competitors within the first hours of going live. Ideas are not important in China—execution is.”

Thanks to that competition and focus on execution, the EV industry went from a niche industrial-policy project to a sprawling ecosystem of predominantly private companies. Much of this happened below the Western radar while China was cut off from the world because of Covid-19 restrictions.

When Western auto executives flew in for April’s Shanghai auto show, “they saw a sea of green plates, a sea of Chinese brands,” said Le, referring to the green license plates assigned to clean-energy vehicles in China. “They hear the sounds of the door closing, sit inside and look at the quality of the materials, the fabric or the plastic on the console, that’s the other holy s— moment—they’ve caught up to us.”

Manufacturers of gasoline cars are product-oriented, whereas EV manufacturers, like tech companies, are user-oriented, Le said. Chinese EVs feature at least two, often three, display screens, one suitable for watching movies from the back seat, multiple lidars (laser-based sensors) for driver assistance, and even a microphone for karaoke (quickly copied by Tesla). Meanwhile, Chinese suppliers such as CATL have gone from laggard to leader.

Chinese dominance of EVs isn’t preordained. The low barriers to entry exploited by Chinese brands also open the door to future non-Chinese competitors. Nor does China’s success in EVs necessarily translate to other sectors where industrial policy matters less and creativity, privacy and deeply woven technological capability—such as software, cloud computing and semiconductors—matter more.

Still, the threat to Western auto market share posed by Chinese EVs is one for which Western policy makers have no obvious answer. “You can shut off your own market and to a certain extent that will shield production for your domestic needs,” said Sebastian. “The question really is, what are you going to do for the global south, countries that are still very happily trading with China?”

Western companies themselves are likely to respond by deepening their presence in China—not to sell cars, but for proximity to the most sophisticated customers and suppliers. Jörg Wuttke, the past president of the European Union Chamber of Commerce in China, calls China a “fitness centre.” Even as conditions there become steadily more difficult, Western multinationals “have to be there. It keeps you fit.”


Chris Dixon, a partner who led the charge, says he has a ‘very long-term horizon’

Americans now think they need at least $1.25 million for retirement, a 20% increase from a year ago, according to a survey by Northwestern Mutual

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