After the collapse of Silicon Valley Bank and Signature Bank the Federal Reserve has indicated it will pump the brakes on any further rate increases. Indeed, I was surprised they went as far as they did to fight inflation given their extreme hesitancy in raising rates at all throughout 2021. But I figured they would blink before “breaking the back of inflation.”
And a new report from JP Morgan is correct, they did more than blink. They injected as much as $2 trillion back into the banking system. All else being equal, more money in the economy means more inflation.
Predominantly through its own negligence (keeping rates so low throughout 2021 and then rapidly increasing them in 2022), the Fed has created a catch-22. Either keep rates high and keep raising them and inevitably throw the economy into recession and cause a bunch of bank failures or let off the gas on rates and bail out (at least) the depositors, thereby injecting additional money into the economy and keeping inflation high.
Th bank failures will come from banks whom, like SVP and Signature that bought lots of HTM (Hold to Maturity) bonds with really low yields that they don't have to devalue until they sell. If or when liquidity dries up and they have to sell, however, it causes a massive devaluation of the bank’s assets which then inevitably leads to a run on the bank.
And while SVP and Signature may have been the worst, they were not by any means the only examples of this. According to a report by the FDIC, there are $620 billion in such unrealized losses on bank’s balance sheets throughout the country. And if the Fed raises rates, those bonds become even less valuable and the amount of unrealized losses grows even higher.
Again, I've been surprised they went after inflation this hard to begin with. But it's not surprising they blinked with SVP. (Which I'll grant is probably the right call given all of the wrongheaded things the Fed has done up to this point.) But don't expect inflation to let up if they keep doing things like this.