US Fed causes a flutter in the market

The US Federal Reserve’s decision on Wednesday to increase the interest rate by 25 basis points, from 5 to 5.25 per cent has sent a flutter across the banking business circles in America. First, there is a sense of relief that there is a slowdown in the pace of rate hike, which had been 50 basis points throughout 2022 and until now. The 25 basis points hike is seen to indicate that the Fed does not feel the need to hike rate aggressively to fight inflation, and it means that inflation is indeed less threatening than it did till now.

Secondly, there has also been a sense of relief that the US has indirectly, and rather cryptically, indicated that it is not hellbent on hiking interest rates to tame inflation. There has been no explicit declaration that there will not be hike rates in the future, but the Fed did not declare its intent to hike rates as it did earlier which is being interpreted as a sign that the Fed has most probably reached the cycle of rate hike. Are business analysts reading too much into the Fed’s undeclared intent?

The American economy is not yet in safe waters, especially with the collapse of Silicon Valley Bank and the First Bank. The Fed managed to auction First Bank and it was taken by J. P. Morgan. It would have been a disaster if the First Bank had melted and there were no takers because it could have triggered panic, a minor one of course, in the financial sector. But analysts are waiting to see if the US Congress and President Joe Biden fail to reach a deal over raising the debt ceiling. The Republican-dominated House of Representatives had passed a bill raising the ceiling but cutting down the President’s spending proposals. Biden is sure to veto the bill, and there will be a deadlock. This would lead to a crisis if no understanding is reached before the end of the month because the US government would default on payments which are due as early as June 1. The question is whether the Fed can bail out the government.

There is nothing surprising about the deadlock between the executive and the legislature in the US because of the separation of powers, where each of the wings is independent and powerful in its sphere. Usually, the White House-Capitol Hill tussle is worked out through tortuous discussions and a give-and-take.

But it puts the Fed in a tight spot. The Fed is happy to do the assigned work of overseeing the economy and making the necessary intervention through interest rate management. But it cannot do anything when the President and the Congress cross swords over how much the government should spend and on what. These are indeed broader policy matters and it is beyond the remit of the Fed which is called upon to decide on matters of monetary policy.

The only advantage of interest rate hike policy of the Fed has been that global funds are returning to the US. But is not of much use if the banks are forced to raise their lending rates as a consequence of the central bank’s rate hike, and this dampens market sentiment. And this is indeed what has happened. The shares rose at the news of the minimal rate hike of 25 basis points, but it fell because the lending rate is at a peak level of 5.25 per cent. And the Fed has not given any indication that the rate hike has reached the peak level, and that it will be brought down in the future.

In these circumstances, the American markets can only be anxious about the uncertainty hanging in the air. Unemployment rate has been fluctuating, and the reasons for joblessness have become complicated. There are not enough skilled people around for the jobs while there are too many looking for jobs. It is a problem that requires a thoughtful, collective response. And the American market is not geared to meet this kind of a challenge. It will be forced to fall back on skilled migrants. American economy has succeeded because it had moved quickly from one new frontier to another. The tech frontier seems to have reached its potential.

The Fed’s monetary policy changes can only help partially in the recovery of the economy. What is needed is a fiscal thrust of the kind envisaged by Biden – the building of infrastructure. But there is no political consensus in the matter.