Just a few months ago, there was renewed hope the U.S. could pull off a rare “soft landing” by snuffing out high inflation without killing off the economic expansion.
The biggest banking crisis in 15 years, sparked by the collapse of Silicon Valley Bank, has put those hopes on thin ice. Other banks are expected to further tighten lending standards to protect themselves and cut off part of the oxygen for the economy.
Lending is the lifeblood of the economy. Consumers borrow heavily to buy big-ticket items like new homes and cars, for example, while businesses rely on credit to expand and invest. High tech, the most dynamic part of the economy, could be the most harmed.
The Wall Street powerhouse Golden Sachs conservatively estimates the crisis could subtract a quarter to half percentage point from gross domestic product, the official scorecard for the economy.
While it might not sound like much, even a drop of that size could be enough to turn GDP negative. After all, many economists were predicting little or no growth in 2023 — if not outright recession — well before the banking crisis.
Read: A ‘zero’ economy? No growth and rising unemployment forecast for 2023
Goldman economists said the expected impact might be “relatively moderate” since lending standards had already tightened due to recession worries. Yet they also said the “risks are tilted toward a larger effect and the uncertainty will likely linger for a while.”
To be sure, the economy is still growing.
GDP rose at an annual pace of 2.7% in the 2022 fourth quarter and it’s on track to expand again in the first three months of the new year. Estimates range from a low of 0.2% to a high of 3.2%.
The U.S. labor market is also extremely strong, with unemployment near a half-century low of 3.6%. A shortage of labor has also boosted wages.
The result is, Americans have money to spend. Consumer spending is by far the main engine of the economy, accounting for more than 70% of all activity.
The big question is how much longer the spending can go on as the economy develops more cracks.
The Federal Reserve has jacked up interest rates to almost 5% from near zero just one year ago in its fight to tame high inflation. And the Fed could raise rates yet again on Wednesday.
The central bank’s about-face after a long era of cheap money is adding lots of stress to the economy.
Take the housing market. Home sales and construction cratered after mortgage rates soared in tandem with the Fed rate hikes.
Rapidly rising interest rates also exposed the faulty business model of SVB and precipitated the current crisis, experts say.
The relatively strong health of the nation’s largest banks is not enough to ease the threat to the economy, either. Chief economist Kathy Bostjancic of Nationwide said small and midsized banks provide almost 70% of all lending to small businesses.
The further tightening of lending standards reinforces Nationwide’s forecast that “the economy is headed for a moderate recession starting in the second half of the 2023,” she said.
If the pessimism is correct, a wide variety of economic indicators should show increasing weakness in the next few months, analysts say.
Chief among them would be the labor market. Hiring is likely to slow sharply and jobless claims — a rough gauge of layoffs — should finally start to rise from near historic lows.
“In sum, the economy is heading for recession and the credit crunch has accelerated the pace,” asserted Steve Blitz, chief economist at TS Lombard.
