Topic 2: US FED RESERVE RATE HIKE

With elevated Inflation and the ongoing US banking crisis, US Fed raised the fed rate by 25bps to 4.75%-5% in March 2023, pushing borrowing costs to new highs since 2007, as inflation remains elevated. The decision came in line with expectations from most investors although some believed that the central bank should pause the tightening cycle to shore up financial stability. After the Fed noted the US banking system is sound and resilient, recent developments are likely to result in tighter credit conditions for households and businesses and weigh on economic activity, hiring, and inflation. PCE (Personal Consumer Expenditures) inflation forecasts were raised for this year (3.3% vs 3.1%), but were kept steady for 2024 (2.5%). The numbers may persuade the Fed that it no longer needs big interest rate hikes to keep inflation in check. But with this aggressive mode of the US FED, the Reserve Bank of India (RBI) is also forced to maintain the Interest Rate disparity to avoid the depreciating currency leading to expensive imports and falling inflation. Irrespective of the Fed Rate hike RBI has to tackle Indian Inflation numbers, leading to higher interest rates. Banks’ lending rate should be increased to maintain their net interest margin.

Since the Fed rates increased at the fastest pace over the last year by 450 basis points from near nil whereas the European Central bank hiked the eurozone by 300 bps. So the value of existing bonds that were issued at lower rates has declined, hence the banks who have these bonds are sitting on unrealized losses. So risk stricken banks already don’t want to take more risks by funding the startups. So the bank was stuck with loss-making government bonds. With the tech bubble burst and layoffs, the bank was in a difficult position. As the news spread about the bank failure, depositors - mostly technology workers and venture capital-backed companies, began to withdraw their money in panic. The soft regulations where the potential loss reserves were reduced for these banks also played havoc

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