The banking crisis should lead to a tightening of credit conditions. The cycle of rising interest rates is coming to an end.
Who would have thought that, in the fight against inflation, the banking system would do some of the work itself instead of the Fed?
In the space of three weeks, the US economy seems to have changed course, moving from the preferred scenario of a soft landing to a hard landing. This would plead for the process of monetary tightening, initiated a year ago, to be shortened. The cause of this change? The banking crisis that erupted on March 8 and its likely consequences for the economy as a whole.
Until then, the Federal Reserve had been counting on a gradual and moderate slowdown in growth, which would result from its successive rate hikes. But more and more professionals were skeptical, like M&M Investments, which says it is convinced that the United States needs a recession to bring inflation back to the 2% target, given the the rigidity of some of its components and the persistent vigor of the labor market.
Vigor at 1is quarter
The statistics published in February and March seemed to prove them right, since they showed stronger-than-expected growth. The US labor market appears very solid, with nearly 830,000 jobs created during these two months.
The preliminary surveys of purchasing managers for March confirmed this positive momentum, particularly in services. As for inflation, measured by the personal consumption expenditure index (PCE), the first data for the fourth quarter have been revised upwards (from 3.2% to 3.7%).
Turnaround
All of this had pushed the head of the Fed, Jerome Powell, to speak quite harshly during his hearing on March 7 before the Senate Banking Committee, leaving the threat of further monetary tightening hanging over. But the situation began to turn around the next day, with the announcement of the bankruptcy of the Silver Bank.
Recession now appears as a likely short-term prospect, following the failure of two other institutions and the shocks suffered by a number of regional and local American banks, which will cause them to tighten their credit conditions.
These establishments play a big role in financing small businesses, which account for nearly half of the country’s total employment, says the management group Pimco. SMEs are therefore “a key vector through which this slowdown will affect the labor market and – with a certain lag – inflation”.
Last turn of the screw
In the meantime, the Federal Reserve revised slightly downwards, on March 22, its growth forecasts for 2023 (from 0.5% to 0.4%) and 2024 (from 1.6% to 1.2%). As activity has recently been stronger than expected, this implies a slight decline in GDP in the coming quarters. However, we should not expect any easing during the year, once the Fed has given its final monetary tightening.
The timing and pace of a future rate cut cycle will depend on how quickly the economy reacts to the ongoing tightening. And the institution itself recognizes that “the magnitude of these effects is uncertain”. Many analysts expect rates to rise one last time in the second quarter and then remain unchanged until at least early 2024.
