Small said the Fed was expected to raise its rate by 50 basis points a couple of weeks ago, but after the collapse of Silicon Valley Bank (SVB) and Signature Bank, he felt it needed to show that things were still fine in the banking industry by raising it by at least 25 basis points – not just to fight inflation, but to send a positive message to the markets that the sector was fine.
In fact, the central bank’s announcement declared that “the U.S. banking system is sound and resilient” and that it planned to continue its course to achieve maximum employment and inflation at the rate of two percent over the long run. It expects to raise rates to the 5% to 5.25% in 2023 to achieve this goal, noting it will also continue to reduce its holdings of Treasury securities, agency debt and agency mortgage-backed securities.
Small, however, warned there is a danger the aggressive interest-rate increases have already gone too far, given they were significant contributors to the collapse of both SBB and Signature Bank.
“You could say their management didn’t make the right decisions, but whenever you raise rates eight or nine times in a span of 12 months, you’re asking for trouble,” he said, adding that while the Fed may be reacting to the strong labour market, that is the wrong indicator to follow since people are returning to work post-pandemic while all the other indicators are showing inflation retreating.
North of the border, Small felt the Bank of Canada pausing its rate hikes was the right thing to do as inflation is already slowing in Canada, though it could take a while yet to get to the desired levels of 2%. Given what’s happened in the banking industry, he said this is a good time for advisors to snap up bank stocks – both Canadian and American – since the core industry is solid, with most Canadian banks yielding 6% to 6.5% dividends.