Recession could come sooner as bank lending cools

CI RegentAtlantic's Andy Kapyrin says potential banking crisis could affect Fed's job

Plunging bond yields, sharp falls in oil and stock prices, and a sharp rise in volatility all point to investor fears that a recession is looming.

Stocks fell on Wednesday as concerns about Credit Suisse spooked a market already worried after regional U.S. bank closures Silicon Valley Bank and signature bank.

“What you’re really seeing is a significant tightening in financial conditions. The narrative in the market is that this increases the risk of a recession, and rightfully so,” said Jim Caron, global head of fixed-income macro strategy at Morgan Stanley Investment Management. “Stocks are down. Bond yields are down. I think the other question is: It looks like we’re pricing in three rate cuts, is that going to happen? You can’t rule that out.”

Bond yields off lows and Stocks recover some lost ground In afternoon trade, after reports Swiss authorities were discussing stabilization options Credit Suisse.

For months, Wall Street has been debating whether the economy is heading for a recession, with many economists expecting it in the second half of the year.

But the rapid volatility in markets following the collapse of regional U.S. banks has some strategists now expecting a faster economic contraction. Economists also assumed lower bank lending, lowering their growth forecasts.

“A very rough estimate is that the slowdown in mid-sized bank loan growth could knock half to a percentage point off GDP levels over the next year or two,” JPMorgan economists wrote Wednesday. There is broad consensus that monetary policy will push the U.S. into recession later this year.”

bank stocks That again helped lead stocks lower after a one-day rally on Tuesday. first republic, For example a 21% drop and west Pacific down nearly 13%. But energy was the worst performing sector, down 5.4%. Oil prices plummet More than 5%. West Texas Intermediate Futures settled at $67.61 a barrel, the lowest since December 2021.

Meanwhile, known as the Cboe Volatility Index shock index, It surged to a high of 29.91 on Wednesday before closing at 26.10, up 10%.

The S&P 500 closed down 0.7 percent at 3,891 after falling to a low of 3,838.

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“Bear market bottoms are usually retested to make sure the lows are actually hit. Recession risks have risen, now exacerbated by the increased likelihood of banks restricting lending,” said Sam Stovall, CFRA’s chief market strategist. “So the open question is Will the Oct. 12 low hold. If not, we see 3,200 in the S&P 500 as another possible target, based on historical precedent and technical considerations.”

The usually more robust Treasury market also saw sharp trading.this 2-Year Treasury Bond Yield It was at 3.93% in afternoon trade, after falling sharply to 3.72%, well below Tuesday’s close of 4.22%. The 2-year note is the best indicator of investors’ views on the direction of Fed policy.

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“I take for granted that people are on edge. I think when I look at the whole thing together, one component of the backlash is [Treasury] Quality-oriented market. There’s also a component to this that says we’re going to tighten credit, Caron said. “We’re going to see tighter lending standards, both in the U.S. for small and medium-sized banks. Even larger banks will tighten lending standards even further.”

The Fed has been trying to fight inflation with a slowing economy and a strong labor market. Consumer Price Index up 6% In February, the numbers are still hot.

But rising news about the banks has heightened concerns among investors that a credit crunch will drag down the economy, a situation that further Fed rate hikes will only accelerate.

For this reason, fed funds futures traded wildly on Wednesday as well, although markets still priced in about a 50% chance of a 25 basis point rate hike by the Fed next Wednesday. Markets are also pricing in multiple rate cuts this year.

“Longer term, I think the market is doing the right thing to price in the Fed, but I don’t know if they’ll cut rates by 100 basis points as well,” said John Briggs, head of global economics and market strategy. Nat West Market. Briggs said he did not expect a rate hike next week. One basis point is equal to 0.01 percent.

“Credit is the grease in the machine and even if the near-term shocks are mitigated and we don’t worry about financial institutions more broadly, risk aversion will start to take hold and take credit out of the economy,” he said.

The response to a slowdown in bank lending could be deflationary, or at least a deflationary shock, Briggs said. “Most small businesses are banked by community regional banks, and after that, even if your bank is fine, are you going to more or less extend credit to that new dry cleaner?” he said. “You’re less likely.”

The Fed’s next move is unclear, CFRA strategists said. “Recent declines in CPI and PPI readings, as well as a contraction in retail sales last month, have increased confidence that the Fed will soften its strict tightening stance. But nothing is clear or certain,” Stovall wrote. “It’s only a week until the FOMC statement and press conference on March 22, but it may feel like an eternity. The wait for tomorrow’s ECB statement and response to Europe’s emerging banking crisis also adds to uncertainty and volatility.”

The European Central Bank meets on Thursday and had been expected to raise its benchmark interest rate by half a percentage point, but strategists said that seemed unlikely.

Economists at JPMorgan still expect the Fed to raise interest rates by 25 basis points next Wednesday and again in May.

“We are expecting a 25 basis point rate hike. Pausing now would send the wrong signal about the seriousness of the Fed’s inflation resolve,” JPMorgan economists wrote. The wrong signal is that the central bank is unwilling to tighten or ease quickly because of concerns about financial stability.”

However, Mark Zandi, chief economist at Moody’s Analytics, said he expects the Fed to hold off on raising rates next week, with the central bank likely signaling that the rate hike cycle is now over.

He doesn’t foresee a recession and thinks a soft landing is still possible.

“I don’t think people should underestimate the impact of these lower rates. Mortgage lending is going to be lower and that should boost the housing market,” he said. Zandi said he doesn’t expect the Fed to turn around and cut rates because its battle with inflation isn’t over.

“I’m a little bit confused by the market saying there’s a 50/50 chance of a rate hike next week and then they’ll call it off. We’ll have to see how that plays out over the next few days,” he said.

Zandi expects growth of 1% to 2% in the first quarter. “But the next couple of quarters could be zero to 1%, we could even have negative quarters, depending on the timing,” he said.

Goldman Sachs economists also Downgraded economic growth forecast for 2023, down 0.3 percentage points to 1.2%. They also pointed to lower lending by small and medium-sized banks and turmoil in the broader financial system.

Correction: This story was corrected to accurately reflect Jim Caron’s comments that the market was pricing in three rate cuts.

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