Fed Raises Rates but Nods to Greater Uncertainty After Banking Stress

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.

Former New Hampshire Gov. Chris Sununu delivered a warning to Treasury Secretary Scott Bessent during a recent visit to Washington: Already-high airfares will surge if the war in Iran doesn’t end soon.

Sununu, a Republican who represents some of the biggest airlines as president of the industry group Airlines for America, has for weeks sounded the alarm to Trump administration officials about the economic fallout from high jet fuel prices. The war, Sununu has argued, must come to a close soon, or things will get worse.

Administration officials have gotten the message.

Privately, President Trump’s advisers are increasingly worried that Republicans will pay a political price for the rising fuel costs, according to people familiar with the matter. Many of those advisers are eager to end the war, hoping prices will begin to moderate before November’s midterm elections.

The fallout from the U.S.-Israeli attack in late February has slowed traffic through the Strait of Hormuz, a vital shipping lane, triggering a sharp increase in oil, gasoline and jet-fuel prices.

That means consumers are grappling with high costs ahead of the summer travel season, as they consider vacation plans.

Sixty-three per cent of Americans said they put a great deal or a good amount of blame on Trump for the increase in gas prices, according to a new poll conducted by NPR, PBS and Marist.

More than 8 in 10 Americans said struggles at the gas pump are putting strain on their finances.

Jet-fuel prices roughly doubled in a matter of weeks after the war began, and they have remained high. Airlines have said that will add billions of dollars of additional expenses this year, squeezing profit margins.

U.S. airlines spent more than $5 billion on fuel in March—up 30% from a year earlier, according to government data.

Carriers have been raising ticket prices, hoping to pass the cost along to consumers, and they are culling flights that will no longer make money at higher price levels.

In March, the price of a U.S. domestic round-trip economy ticket rose 21% from a year earlier to $570, according to Airlines Reporting Corp., which tracks travel-agency sales.

So far, airlines have said the higher fares haven’t deterred bookings and they are hoping to recoup more of the fuel-cost increases as the year goes on.

Earlier this week, Trump said the current price of oil is “a very small price to pay for getting rid of a nuclear weapon from people that are really mentally deranged.”

Secretary of State Marco Rubio told reporters that if Iran got a nuclear weapon, the country would have more leverage to keep the strait closed and “make our gas prices like $9 a gallon or $8 a gallon.”

Trump has taken steps in recent days to bring the war to an end. Late Tuesday, the president paused a plan to help guide trapped commercial ships out of the Strait of Hormuz, expressing optimism that a deal could be reached with Iran to end the conflict.

Crude oil prices fell below $100 a barrel on Wednesday, after reports that Iran and the U.S. are working with mediators on a one-page framework to restart negotiations aimed at ending the conflict and opening the strait.

Sununu said Trump administration officials are conscious of the economic fallout from the war: “They get it…and I think that’s why they’re trying to get through the war as fast as they can.”

But he cautioned that it could take months for prices to return to prewar levels.

“Ticket prices won’t go down immediately” after the strait is fully reopened, Sununu said. “You’re looking at elevated ticket prices through the summer and fall because it takes a while for the prices to go down.”

Since the initial U.S.-Israeli attack in late February, Sununu has met in Washington with National Economic Council Director Kevin Hassett, representatives from the Transportation Department and senior White House officials.

A White House official confirmed that Hassett and Sununu have discussed the effect of increased fuel prices on the airline industry. The official said the conversation touched on how the industry can mitigate the impact of high jet fuel prices on consumers.

“The president and his entire energy team anticipated these short-term disruptions to the global energy markets from Operation Epic Fury and had a plan prepared to mitigate these disruptions,” White House spokeswoman Taylor Rogers said, pointing to the administration’s decision to waive a century-old shipping law in a bid to lower the cost of moving oil.

Rogers said the administration is working with industry representatives to “address their concerns, explore potential actions, and inform the president’s policy decisions.”

A Treasury Department spokesman pointed to Bessent’s recent comments on Fox News that the U.S. economy remains strong despite price increases. The spokesman said Treasury officials have met with airline executives, who have reaffirmed strong ticket bookings.

“We’re cognizant that this short-term move up in prices is affecting the American people, but I am also confident, on the other side of this, prices will come down very quickly,” Bessent told Fox News on Monday.

The war has already contributed to one casualty in the industry: Spirit Airlines. Company representatives have said they were forced to close the airline because the sustained surge in jet-fuel prices derailed the company’s plan to emerge from chapter 11 bankruptcy.

The Trump administration and Spirit failed to come to an agreement for the company to receive a financial lifeline of as much as $500 million from the federal government.

Transportation Secretary Sean Duffy has argued that the Iran war wasn’t the cause of Spirit’s demise, pointing to the company’s past financial struggles, as well as the Biden administration’s decision to challenge a merger with JetBlue.

Other budget airlines have also turned to the federal government for help since the U.S.-Israeli attack. A group of budget airlines last month sought $2.5 billion in financial assistance to offset higher fuel costs, and they separately wrote to lawmakers asking for relief from certain ticket taxes.

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

Administration officials have spoken to the airline industry, which has voiced concerns about the rising costs.