The current accumulated troubles in the U.S. banking sector are far less severe than in 2008. During that time the primary reason the banking sector was hit badly was the bursting of the housing bubble, an even that left little hope for a recovery. This was followed by a collapse of the government-sponsored enterprises Fannie Mae and Freddie Mac, which had their own bonds accepted as collateral by many banks. The infamous Lehman Brothers did not survive the crisis and crashed.

This time the news that some banks were suffering from a lack of liquidity emerged after their assets were devalued amid rising interest rates. The rise of the Federal Reserve’s (Fed) interest rates by 1.00 percentage points lead to a 10% decline in 30-year U.S. Treasuries.

However, nobody disputes the safety of Treasuries. So, there is no bubble like in 2008. Silicon Valley Bank (SVB) could hold its Treasuries until their maturity and could get the whole amount of funds needed. But the urgent deposit withdrawals led to panic. These funds are currently used as collateral under the Bank Term Funding Program which was launched by the Fed and Finance Ministry, and are being redeemed at nominal value. Even the scale of these banking issues is small.

The Global Financial Crisis in 2008 led to a collapse of 25 banks, and 140 banks in 2009, according to the Federal Deposit Insurance Corporation (FDIC). Now such catastrophic troubles are only visible in three American banks. This time financial watchdogs almost immediately reacted to extinguish a possible fire in the banking sector as they provided all liquidity needed to ensure all requested withdrawals will be delivered.

Major American banks joined financial authorities’ efforts to eliminate liquidity troubles and provide the necessary funds. Moreover, the European Central Bank (ECB), the Bank of Canada, the National Bank of Switzerland, and the Bank of Japan joined the Fed and provided Dollar liquidity to mitigate any possible consequences of these banking troubles.

But even the sheer fact that all these measures had to be put into operation has created doubts in clients’ minds that all this may not be enough to avoid bigger problems. According to Wall Street Journal, 186 American banks are in a dangerous situation amid deposit withdrawals. Nonetheless, it seems that this is an all-or-nothing decision to provide as much funds as needed without any limits. The Fed’s balance has jumped by $297 billion or 3.6% in one week, just on emergency lending. The balance rose to $8639 billion from $8342 billion. The Fed needed four months to clear its balance for this amount of assets, as it started quantitative tightening in November 2022. This is close-loop configuration, as the Fed needs to raise interest rates to fight blistering inflation.

The Consumer Price Index (CPI) slowed down to 6% year-on-year in February compared to 6.4% a month earlier. Core CPI, without volatile food and energy prices, was merely unchanged at 5.5% in February compared to 5.6% a month before. Core CPI rose by 0.5% in February vs 0.4% in the first month of 2023. So, it is too early to claim victory over inflation.

Esperio analysts believe that The U-turn to Quantitative easing in such situations is highly unlikely, just as an increase of interest rates is also unlikely in this regard, as it may amplify banking troubles. However, an interest rate hike to 5.00% makes more sense as it would demonstrate the Fed’s commitment to battle inflation, to prove that the banking system remains solid, and therefore show that no issues could escalate towards a crisis. The recent bold decision of the ECB to raise its interest rates to 3.5% from 3.00% should also be considered. A pause in the interest rate hiking cycle could be even more critical, as it may be interpreted as confirmation of the severity of banking troubles, and the uncertainty of how these troubles could be resolved.

Nevertheless, banking troubles could disrupt any attempt to further raise rates. So, the interest rate hiking cycle may be terminated as the Fed could temporary accept its misfortune in bringing inflation under control, and anchor inflation at it 2% target.

by Alex Boltyan, senior analyst of Esperio company