The week in the markets -
May 5, 2023

Fed increases rate and U.S. regional banks under the microscope

• The U.S. Federal Reserve increased the federal funds rate by 25 bps.
• First Republic Bank was seized by regulators and sold to JP Morgan Chase.
• Oil commodity prices contracted as global economies slowed slightly.
   

The U.S. Federal Reserve announced a 25-basis-point increase in its key interest rate, bringing it to a range of between 5% and 5.25%. This was widely anticipated by market participants, given the Fed’s determination to continue to fight inflation, plus the strong labour market (with record-low unemployment rates). The decision to hike rates, in the face of an increasingly cloudy economic backdrop, came as consumer spending has flattened, suggesting that many shoppers have grown cautious in the face of higher prices and increased borrowing costs. The manufacturing sector is also showing signs of continued contraction, with the ISM Manufacturing Index in April coming in at 47.1, driven by a reduction in new orders and rising borrowing costs.

While the labour market remains strong, with 1.7 jobs for every unemployed person in the U.S., job openings are trending downwards, indicating that employers are becoming more cautious in their hiring decisions because of slowing global economic growth. The U.S. economy continues to grow at a slower pace, with the latest GDP data showing a 1.1% annualized growth in the first quarter (below the 2% forecast).

Fed Chair, Jerome Powell, believes that the recent banking collapses will likely cause other banks to tighten lending to avoid similar fates. This could lead to lending cutbacks that may help slow the economy, cool inflation and reduce the need for the Fed to raise rates any further. Inflation has dropped from a peak of 9.1% in June of last year; new CPI data is due out next week. The Fed also stated that its string of rate hikes had not sufficiently cooled the economy, the job market or inflation, and any decision to pause future rate hikes would signal a shift from current monetary policy.

Investors continue to watch the ongoing regional banking turmoil in the U.S. as First Republic Bank was seized by regulators and sold to JP Morgan Chase. While First Republic did not suffer from any specific systemic risks, a decline in deposits in March led to its failure. JP Morgan Chase is set to take the remaining US$92 billion in deposits at First Republic and most of its assets, including US$173 billion in loans and US$30 billion in securities.

The energy sector slipped, as oil traded below historical levels. This was due to fears of a more contracted global economy and signs that China's expected rapid demand and growth following its reopening have been lower than expected. There are also ongoing headwinds from tightening credit. Next week will see fresh data on U.S. inflation and housing.