From Sound to Stress: The State of the Banking System in Today's Financial Challenging Times

Inflation and the Federal Reserve: Why Rate Hikes May Not Address Root Causes

Key Takeaways

• The Federal Reserve's tenth interest rate hike may not reduce inflation, and the current financial crisis could be worse than 2008 due to structural changes in the economy.
• The banking system is under stress, with concerns about credit and a potential crisis. Banks are struggling due to loading up on low-yielding treasuries, mortgage-backed securities, and other loans.
• People are moving money out of banks and into the markets, causing more problems. The Federal Reserve's rate increases may not be effective against the root causes of higher inflation.

What’s Happening:

The Federal Reserve has raised interest rates for the tenth time, but this does not necessarily mean that inflation will go down. In fact, according to some experts, the financial crisis we are currently facing is the worse since 2008. One of the most important issues is the focus on credit, which is already a concern for the senior loan survey that is due to come out soon. It is expected to be similar to the European Central Bank survey, which was not good news. This has put a lot of pressure on the Regional Bank space.

One of the main problems is the fact that the banking system is sound and resilient, according to the Federal Reserve, but we have heard this before. The banking system is fine until it is not, and that is what is happening now. When the banking system is under stress, a financial crisis can begin just on the fear of the unknown. As Warren Buffett says, a lite match can be blown our or with tinder start a huge blaze.

The elephant in the room is inflation. Part of the challenge is the potential from structural inflation and ultimately inflation expectations. Structural inflation comes from dynamics in the labor force causing lower participation, less productivity, and the re-shoring of manufacturing from lower cost countries back to the United States.

The Federal Reserve has raised interest rates repeatedly to quell inflation, but it does not seem to be working. The trajectory of inflation has been decreasing, but it is still going to be a problem. The Federal Reserve has raised interest rates to stop inflation, but it is not working because it is not addressing the root cause of the problem.

The banks are in trouble because they were allowed to load up on overpriced, low-yielding treasuries, mortgage-backed securities, and other loans. This was encouraged by the Federal Reserve and the US government, but now the whole system is understress, and they are trying to figure out how to put out a fire that they lit. The banks are now feeling the pain because they were allowed to keep interest rates at zero for too long.

The banking crisis may not be over. Too many easy alternatives exist, and people are moving their money out of banks into the markets, which is causing even more problems.

Our take:

The Federal Reserve has raised interest rates for the tenth time, but this does not mean that inflation will go down. The banking crisis is not over, and people are moving their money out of banks into the markets. Structural changes in the economy may be at the root of the higher inflation and the Federal Reserve’s rate increases are less effective against these types of changes.