Stocks slid after officials at the Federal Reserve announced a 0.25% increase in the target federal funds rate on Wednesday, continuing a slowdown from previous rate hikes meant to combat inflation and marking caution from policymakers given recent tumult in the banking sector.
Rate hikes increase the cost of borrowing money, lowering inflationary pressures as consumers and businesses assume less debt. Federal Reserve officials previously set interest rates targets between 0.0% and 0.25% during the lockdown-induced recession to stimulate economic activity; target interest rates now sit between 4.75% and 5.0%.
“Recent indicators point to modest growth in spending and production,” members of the Federal Open Market Committee said in a statement. “Job gains have picked up in recent months and are running at a robust pace; the unemployment rate has remained low. Inflation remains elevated.”
The Dow slid more than 500 points on Wednesday and closed 1.6% lower than market open, with regional bank shares leading the decline.
As inflation remained elevated and rose to levels as high as 9.1% in June 2022, policymakers at the Federal Reserve raised rates by 0.75% on four occasions before implementing a 0.5% hike at the end of last year. Inflation rates were charted at 6.0% as of February 2023.
The decision to hike interest rates announced on Wednesday was complicated by the implosion of Silicon Valley Bank and Signature Bank earlier this month, as well as broader international volatility in the financial sector. Silicon Valley Bank had been forced to sell a long-term bond portfolio at a loss because of the higher interest rate environment as account holders whose balances exceeded the $250,000 threshold insured by the Federal Deposit Insurance Corporation rushed to withdraw their funds; the government-backed company nevertheless insured all accounts to discourage bank runs at other firms.
Federal Open Market Committee members added in the statement that they believe the financial system is resilient. “Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation,” the body added. “The extent of these effects is uncertain.”
One recent study from National Bureau of Economic Research analysts revealed that more restrictive monetary policy from the Federal Reserve has caused the value of bank assets to decrease by 10%, indicating that the overall financial system’s assets are $2 trillion lower than their book value. The “substantial losses in the value of banks’ long-duration assets” indicate that “banks are much more fragile” to runs from uninsured depositors.
Federal Reserve Chair Jerome Powell had said days before the turmoil in the financial sector that robust labor market data and persistent inflation in some product categories meant that policymakers would continue to increase target interest rates. Despite the low unemployment rates, household wages have declined over the past two years when adjusted for inflation.
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“We continue to anticipate that ongoing increases in the target range for the federal funds rate will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive,” he said in remarks before members of the Senate Banking Committee. “We are seeing the effects of our policy actions on demand in the most interest-sensitive sectors of the economy. It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation.”