Jay Powell has another problem now: Morning Brief

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Friday March, 10, 2023

Today’s newsletter is by Myles Udland, Head of News at Yahoo Finance. Follow him on Twitter @MylesUdland and on LinkedIn. Read this and more market news on the go with the Yahoo Finance App.

For the last year, the Federal Reserve has tried to accomplish one goal, using one tool — lower inflation by raising interest rates.

The result has been benchmark interest rates rising by 4.5% in a year and headline inflation falling from a peak of 9.1% in June to 6.4% as of January. As Fed Chair Jerome Powell reiterated in testimony on Capitol Hill this week, there is still work to be done for the Fed to achieve its goal.

But over the last week, acute challenges at two banks have surfaced another issue now facing the Powell Fed. And that is the stability of the financial system.

On Wednesday, Silvergate Capital (SI), which had become one of the crypto industry’s biggest banking partners, announced it will liquidate and wind down operations after suffering significant deposit outflows from its digital asset clients.

That same day, Silicon Valley Bank (SIVB), the preferred banking partner of the venture and startup worlds, announced it would take a $1.8 billion loss while liquidating its entire short-term securities book and raising $2.25 billion fresh capital.

In a letter to investors, CEO Greg Becker assured investors the bank had “ample liquidity,” and said it took these actions “because we expect continued higher interest rates, pressured public and private markets, and elevated cash burn levels from our clients as they invest in their businesses.”

The Information reported Thursday afternoon Becker told investors on a call, “I would ask everyone to stay calm and to support us just like we supported you during the challenging times.”

Few statements have a tougher audience than investors being told to remain calm in times of market stress.

On Thursday, U.S. stocks got crushed during a steady, relentless sell-off that centered on the financial sector. Regional banks were hammered. Big banks were hammered. The S&P 500 fell 1.8%. Bitcoin fell 7%.

The challenge for Powell, however, is that some of the stress facing Silicon Valley Bank has been induced by the Fed’s actions to fight inflation. And the fear is they may not be alone.

In the simplest terms, Silicon Valley Bank took a nearly $2 billion hit selling bonds at a loss to buy different bonds that offer a higher yield. The firm’s latest annual report showed the bank owned about $14 billion in Treasury securities with an average maturity between 1-5 years. Today, 1-year Treasury bills yield 5.25%.

One day’s drop in the stock market, of course, is not cause for concern about the financial system. Even the liquidation of one bank and deep investor concerns about another need not constitute a Fed-level worry about the U.S. banking system.

But these moves serve as reminders that while the central bank’s role in raising or lowering interest rates has become the focal point of investor attention over the last decade, the Fed also serves the central role in stabilizing markets and quelling investor fears during uncertain moments like the present.

Almost exactly three years ago, Powell held an emergency Sunday night call on March 15, 2020 to announce a series of measures aimed at supporting the economy as the pandemic rapidly shut down global business.

On that call, Powell reminded the assembled press, “[That] central banks were originally designed to …provide liquidity to financial systems in stress, so we take that job very seriously. It’s probably the most important thing we’re doing now is that.”

Federal Reserve Chair Jerome H. Powell testifies before a House Financial Services hearing on

Federal Reserve Chair Jerome H. Powell testifies before a House Financial Services hearing on “The Federal Reserve’s Semi-Annual Monetary Policy Report” on Capitol Hill in Washington, U.S., March 8, 2023. REUTERS/Kevin Lamarque

Rising anxiety in the banking system as the ripples from a crypto collapse in 2022 and the icing over of a red hot venture market pale in comparison to the financial emergency the Fed faced three years ago. But their actions then were a reminder of the central bank’s power, and, indeed, its centrality to financial markets.

When the February jobs report is released Friday morning, investors will pore over the data to decipher whether a 0.25% or 0.50% rate hike from the Fed is likely warranted on March 22.

This is the moment markets have been building towards for weeks.

But the unforeseen stress now being injected into the banking system makes Friday and the days ahead notable for the Fed in an entirely different manner.

And presents to Jay Powell another wrinkle in the challenge of trying to bring order to an economy that busted and boomed in a few short months.

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