BATTLING inflation and a crisis of banking confidence, the Federal Reserve is fighting a war on two fronts. 

Investors are worried that it’s concentrating too much of its forces on the inflation front. 

On Wednesday (Mar 22), the Fed raised its benchmark rate by a quarter of a percentage point, and sketched out a vision for at least one more hike in the balance of the year.  

While chairman Jerome Powell acknowledged the central bank considered a pause in its rate-hike cycle because of the series of bank runs, officials concluded inflation was the more imminent threat. 

The most likely lasting effect from the failures of Silicon Valley Bank (SVB), Signature Bank and Credit Suisse Group is a slowdown in lending activity, the Fed said. 

With many more banks now in survival mode, they are likely to pull in their horns and make it harder for businesses and homebuyers to borrow. That will slow economic activity.

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“While granting that these developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring and inflation, the Fed reiterated its concurrent focus on inflation risks,” said Taimur Baig, chief economist at DBS.

Powell indicated he saw little chance of the bank runs spreading. The only banks at risk of going the way of SVB were those that made the same mistakes, he said.

“At a basic level SVB management failed badly… they grew the bank very quickly, and exposed it to liquidity risk and interest-rate risk,” said Powell. 

SVB had a “concentrated group of depositors” – the tech-industry elite – said Powell. Once alarms sounded among those depositors, the bank experienced a “very fast” run, faster than any seen before, said Powell.

After all, these days, money can be moved out of a bank in a “nanosecond”, noted Quincy Krosby, chief global strategist at brokerage LPL Financial.

SVB and Signature Bank were unusual in the large proportion of uninsured deposits they carried, said one strategist.

“You had a very unique case of concentration risk coupled with interest-rate risk, and that’s not something that is common,” said Oliver Pursche, senior vice-president at financial advisory Wealthspire.

Powell’s dismissal of the crisis may have been a calculated attempt to avoid panicking markets further. If so, it didn’t work.

Shares of First Republic Bank, another Silicon Valley lender facing an exodus of despositholders, plummeted after Powell’s press conference.  

The same happened to PacWest, the parent of Pacific Western Bank, which warned on Wednesday that it had lost 20 per cent of its deposits to withdrawals since the start of the year. 

Shares of both banks plummeted after Powell’s sanguine comments on the crisis and as Treasury Secretary Janet Yellen told Congress she was not planning blanket insurance of deposits.

The Fed did change its strategy slightly in response to the panic. Before the failure of SVB, the central bank had hinted that it was going to raise rates by 50 basis points to tame resurgent inflation. 

The statement also changed slightly from February, removing a phrase about the necessity for “ongoing” rate increases. 

But it’s what didn’t change that shocked markets. In the 2008 financial crisis, the Fed acted preemptively, cutting rates repeatedly to shore up the financial system.

This time around, Powell said, there’s unlikely to be any rate cuts at all. Some investors fear the Fed is complacent about risks that rate increases like Wednesday’s will put even more pressure on the fragile banking sector.

Others say the central bank cannot relent in its inflation battle. While the annual rate of inflation is much lower than it was six months ago, it’s dizzyingly high by any other standard.

Powell stubbornly insisted that the Fed would not rest until consumer-price inflation came down to the traditional 2 per cent target – something most economists say is a long way off. 

Prices will face upward pressure for months even if lending activity slows, said strategists at brokerage Jefferies, in a note to clients.

“Barring an increase in contagion risk within the banking sector, we expect that the Fed will be faced with a very similar policy decision in May, and they will be compelled to deliver another hike,” said the strategists.