Economists have been forecasting a US recession would happen since the Federal Reserve (Fed) started raising interest rates back in March 2022. The federal funds rate has risen almost 500 basis points since last year, as the Fed has aggressively attacked inflation.
J. Patrick Bradley, Senior Vice President – Investment Research at Brandywine Global, part of Franklin Templeton says: “On the other side of the coin, there is a sizable contingent who still assert that a soft landing remains possible.
“I am not in that camp. The exact timing of when a potential recession might begin is lacking, but a fledgling U.S. banking crisis may have shortened the timetable. Let us look at where we are in the business cycle and see if there are any recessionary signals.
“Most likely, in my view, a recession is baked in now. The U.S. has just experienced three regional bank failures. The failures of Silicon Valley Bank and Signature Bank saw a surge in discount window borrowing. Next, First Republic Bank became the latest bank to fail, earning the dubious distinction of being the second-largest bank failure in U.S. history. Now, other struggling banks, hoping to avoid the same fate, are actively seeking suitors. This turmoil and uncertainty will ripple through the economy just as the steadfast tightening of U.S. monetary policy is also manifesting in financial conditions.
“Some experts may believe the banking crisis is over, following the purchase of First Republic’s assets and deposits by JP Morgan. I am less reassured. The Fed appears to be staying the course on its rate-hiking path, putting banks and other interest-rate sensitive sectors under further strain. These potent ingredients of the Fed’s earlier hikes and recent bank failures suggest recession is likely baked into the mix.
“Tight monetary policy and failing banks further suggests a U.S. recession is baked in. The U.S. economy is slowing; financial stress is evident; credit availability is constrained by the banking failures—and likely to tighten further; leading indicators are falling; and the probability of a recession, according to some analyses, is rising.
“Whether or not the Fed quickly reverses the direction of its policy will not alter my expectation of a recession. Monetary policy operates with long and variable lags, with an emphasis on long. More banks could fail. Markets do not have confidence that the financial crisis is over. The S&P 500 regional bank index plunged nearly 28% in the days following the fall of Silicon Valley Bank (SVB) and Signature Bank. Thus far, the index has failed to recover. Furthermore, it is likely we are only beginning to see the impact of all the prior cumulative monetary tightening.
“The combination of this added stress from the banking sector in conjunction with the Fed-generated reduction in liquidity likely will magnify and accelerate the eventual outcome: A recession appears baked into the economic cake,” says Bradley.
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