The implosion of a third US bank this week threatens to exacerbate the credit crunch for US households and businesses, leading to more losses. Economic growth This is already slowing down.
Lending standards had already become dramatically more restrictive after the crash Silicon Valley Bank and Signature Bank in March.
Fed data released in mid-April showed that commercial bank lending fell by about $105 billion in the last two weeks of March, the largest drop in lending on record.
“The data suggests that a credit crunch has begun,” Morgan Stanley analyst Mike Wilson said during a recent episode of the firm’s “Market Thoughts” podcast.
During a credit crunch, banks raise their lending standards dramatically, making it difficult to get a loan. Borrowers may have to agree to tougher terms such as higher interest rates as banks try to reduce financial risk on their end. Fewer loans, in turn, will lead to less big-ticket spending by consumers and businesses.
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Although JPMorgan Chase closed a deal Monday to buy beleaguered First Republic in an effort to allay market concerns about volatility in the financial sector, economists remain concerned about tighter lending terms.
“Investors and policymakers should expect that as banks tighten lending standards and taper off credit provision, the current pace of growth in the economy will slow further as small and medium-sized businesses that rely on local and regional bank lending further reduce productivity,” said Joe Brusolas, senior RSM economists: “- boost investment in software, equipment and intellectual property and certainly reduce employment.”
While that may help the Fed in its battle to rein in stubbornly high inflation, it also raises the risk of a recession this year.
Gregory Daco, chief economist at consulting firm EY-Parthenon, similarly said he believes tightening credit will constrain “business investment, employment growth and consumer spending in the coming months.”
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“The potential for a recession has risen due to increased financial market volatility, tightening credit conditions, and economic uncertainty,” Daco said. “While labor market conditions still appear to be relatively resilient, a sudden shift in sentiment combined with a rapid tightening of financial conditions could tip the economy into a recession as businesses and consumers slump.”
Federal Reserve Chairman Jerome Powell acknowledged during the Fed’s two-day meeting in March that turmoil within the financial sector could tighten credit to US households. He noted that stricter lending standards could have a similar effect on inflation that an interest rate hike would.
“Such tightening in financial conditions will work in the same direction as rate tightening,” Powell said. “You can think of it as the equivalent of a rate hike or maybe more than that.”
His comments came shortly after policymakers raised the interest rate by a quarter of a percentage point, which pushed the benchmark interest rate into a range of 4.75% to 5%, the highest since 2007. It was the ninth consecutive increase aimed at combating inflation. high.
Federal Reserve officials are in the midst of their most ferocious tightening campaign since the 1980s as they try to crush inflation that remains three times higher than the pre-pandemic average.
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But fears of a broader financial crisis have complicated the Fed’s efforts, since the rapid rise in interest rates played a direct role in the failure of the Silicon Valley bank. An increase in interest rates threatens to exacerbate instability within the financial system. Powell said it was too early to say how banking sector pressures would affect the broader economy.
“It appears that financial conditions have tightened, perhaps by more than what conventional indicators suggest,” he said. “But the question for us is how important is that — how big is it, how long is it?
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“We will be looking to see how severe this is and does it look like it will continue. If it is, it could easily have a significant macroeconomic impact, and we will take that into account in our policy decisions.”
Policymakers are widely expected to agree to a 10th consecutive rate hike at the close of their two-day meeting on Wednesday and hint at an upcoming pause in the increases.