As expected, the FOMC raised short term interest rates for the tenth consecutive meeting, boosting the Federal Funds Rate by 25 basis points to 5.25%, the highest benchmark level since 2007. While it may seem odd that the FOMC would be raising rates at a time when three, large regional banks failed within 60 days of each other, this is no ordinary time. Boxed in by a late response to obvious inflationary pressures, the FOMC delivered 500 basis points of rate hikes in 13 months, the fastest pace of tightening in history, to tame the highest inflation since the early 1980s. Among other things, this white-hot pace has created a growing divide between bank deposit rates and the yields on other, short-term investment products, namely U.S. Treasury bills and Money Market Funds, triggering depositors to withdraw funds from banks in favor of these higher yielding alternatives. As a yet to be known number of regional/community banks now grapple with the reality of deposit withdrawals and asset shrinkage, the real question now is how far a meaningful credit contraction can go, and at what cost to the economy.
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