For banks, Fed’s aggressive rate hike cuts both ways

The Federal Reserve’s 75-basis-point interest rate hike Wednesday, the largest increase since 1994, will almost certainly bolster banks’ 2022 earnings, analysts say — but the steep increase signals a stronger threat of a recession.

The Fed’s third rate increase of the year, with another looming in July, "will probably induce a slowdown in the economy,” Rohit Arora, CEO of the New York-based Biz2Credit, said in an interview. “Whether it leads to a full-blown recession or a mild recession is something to be seen."  

The Fed’s benchmark federal-funds rate rose to a range between 1.5% and 1.75% following policymakers’ decision Wednesday. 

“From the perspective of today, either a 50-basis-point or a 75-basis-point increase seems most likely at our next meeting” on July 26-27, Fed Chairman Jerome Powell said at a news conference Wednesday.

Banks’ adjustable-rate loans reset upward after Fed rate increases, boosting lending profitability, analysts at Raymond James said in a report. The latest Fed move “will be positive to nearly all” bank bottom lines, but especially for those with large commercial-and-industrial portfolios. C&I loans are often larger and carry adjustable rates, making them particularly impactful, the analysts said.

Andrew Harrer/Bloomberg

That said, with the aggressive shift in Fed policy comes the risk of overreaching, raising rates so much that spending stalls and the economy dips into recession. Powell said the Fed is seeking a so-called soft landing by raising rates just enough to curb spending and blunt inflation without bringing the economy to a screeching halt.

But he conceded the risk of recession has escalated. 

“We’re not trying to induce a recession now. Let’s be clear about that,” Powell said. However, it “is not going to be easy. There’s a much bigger chance now that it’ll depend on factors that we don’t control.”

Powell pointed to surging commodity prices, most notably energy and fuel costs, that drove inflation to a 40-year high of 8.6% in May. The U.S. Labor Department said energy commodity costs, including oil and gas, ballooned 50% in May from a year earlier as demand outstripped supply.

Western sanctions against Russia have amplified the problem. Russia is a major oil and gas producer, but the sanctions have crippled its energy complex. Lingering pandemic impacts on supply chains also cause challenges, exacerbating inflation in ways the Fed may not be able to address without tilting the economy in recession.

“The risk comes later when the Fed overshoots or gets political pressure to undershoot,” said Chris Nichols, head of capital markets at the $46.2 billion-asset SouthState Corp. in Winter Haven, Florida.

Banks rush to increase prime rates after Fed’s big hike

In other words, the Fed is walking a tightrope. If it falls one way, it plunges into recession. If it falls the other way, it's inflation that could eventually paralyze consumer spending and induce a recession.

A souring economy raises credit quality concerns for banks. During recessions, the number of borrowers who struggle to make credit payments often jumps, forcing banks to charge off bad loans and absorb losses.

The Fed’s latest projections showed all 18 policymakers who participated in the meeting this week expect the Fed to raise rates to at least 3% this year. Half of them indicated the central bank’s benchmark rate may need to rise to around 3.375% this year.

Bank executives are increasingly concerned. Even before the Fed’s move this week, a Piper Sandler survey of more than 40 bank chief financial officers found that two thirds of them expect a recession in the first half of 2023. Another 20% anticipate an economic slump in the second half of next year.

In total, “a shockingly high 86% of the CFOs expect a recession in 2023, a worrisome outlook,” said Piper Sandler’s head of research Mark Fitzgibbon.

“Since bank executives are in the unique position of seeing the financial condition of their consumer and commercial customers in great detail,” he added, “they often have a uniquely good perspective on the strength of balance sheets, economic activity and areas for concern.”

John Reosti contributed to this report.