US bank turmoil seen crimping credit at double Fed’s estimate, tipping economy into recession

Atlanta – US bank stress will tighten credit by twice as much as expected by Federal Reserve chairman Jerome Powell, said economists surveyed by Bloomberg, tipping the economy into recession.

Almost all of the economists expect the Federal Open Market Committee (FOMC) to hike interest rates another quarter percentage point at its May 2-3 meeting to a target range of 5 per cent to 5.25 per cent.

But the higher borrowing costs will be amplified by the fallout from the March collapse of two United States banks, which a majority of the economists found to be equivalent to a Fed hike of about half a percentage point or more. Mr Powell has estimated the impact at roughly a quarter point.

“Inflation remains unacceptably high, but banking stresses are leading to a tightening of lending conditions and this will do more to slow the economy than the likely 25-basis-point hike on Wednesday,” said Mr James Knightley, chief international economist at ING, in a survey response.

The survey of 46 economists was conducted from April 21 to 26.

Fed officials have mostly downplayed the impact on monetary policy from the failures of Silicon Valley Bank and Signature Bank, although they have expressed uncertainly over how evolving credit conditions will affect growth in the remainder of the year. In addition to those two failures, First Republic Bank’s shares plunged this week after encountering huge outflows of deposits.

The Fed has made emergency loans to banks and the authorities have guaranteed deposits in excess of stated limits to try to stem the crisis. A majority of the economists say the banking woes are mostly over, while another quarter say the crisis is about half over.

The resulting credit impact will be significant, the economists found. Almost all of the economists say banks will tighten lending standards, with the biggest impact on commercial real estate loans. A majority see lending standards on real estate loans tightening somewhat and 41 per cent see a considerable impact. Nearly three-quarters of the economists expect substantial losses in the office sector.

“We expect deposit outflows to continue,” Nomura Securities economists Aichi Amemiya and Jacob Meyer said. “This is likely to be a key cause of reduced bank lending in the coming quarters, which we expect to generate notable economic headwinds.”

Views on the impact on monetary policy are diverse, with 43 per cent of the economists estimating it as equivalent to a half-point hike and another 13 per cent seeing it amounting to between a 75-basis-point and 150-basis-point hike, while a quarter agree with Mr Powell in seeing it as a quarter-point impact.

The exact impact may not be easy to calibrate and can be unpredictable, said Ms Julia Coronado, president of MacroPolicy Perspectives and a former Fed economist.

“Thinking in terms of rate hike equivalents leads us to think about monetary policy in a dangerously linear way,” she said. “The faster the tightening, the greater the risk of non-linear financial stability events that can lead to a non-linear tightening in credit.”

The Fed has engaged in the most aggressive interest rate hiking in 40 years to try to fight persistently high inflation. The upshot: The hiking and the banking crisis will tip the economy into recession within the next 12 months, according to two-thirds of the economists. Among those who expect a downturn, four-fifths expect it to start in the current quarter or next quarter.

“By outsourcing the rest of the fight against inflation to credit tightening by the banks, it has become even more difficult for the Fed to engineer a soft landing,” said Mr Philip Marey, senior US strategist at Rabobank. “Consequently, we think a recession has become more likely.”

While FOMC officials have not explicitly predicted a recession, the Fed staff at the last meeting forecast a mild recession and policymakers’ forecasts made in March suggest a sharp reduction in growth this year. BLOOMBERG