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The U.S. economy faltered in the weeks following the collapse of Silicon Valley Bank, as consumers spent less, factories slowed their assembly lines, and the nation’s bankers became more cautious about lending.
If those trends continue, the recession that many analysts have been predicting for much of the past year will finally arrive in the coming months.
But during the recovery from the coronavirus pandemic, the $26 trillion U.S. economy has defied expectations, creating new jobs at a remarkable pace and avoiding the oft-predicted downturn. Like a prizefighter taking a blow, he can still regain his balance and endure.
However, the news on Friday was not great. Retail sales fell for the second straight month as Americans bought fewer cars, clothes and furniture. Production output fell. And commercial bank lending rose only slightly after two weeks of declines. New corporate loans rose just $30 billion in March, the smallest monthly gain since mid-2021, as the pandemic gained momentum, according to the Federal Reserve.
“I think it’s increasingly likely that we’re going into some form of recession,” said Gregory Daco, chief economist at EY Parthenon. “We are seeing increasing signs of a slowdown in economic activity.”
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Aftershocks from the recent banking turmoil make a recession more likely, Jamie Dimon, CEO of JPMorgan Chase, the country’s largest bank, told analysts on Friday. The sudden bankruptcy of two US banks and the takeover by a European rival of Credit Suisse, a global titan, made other institutions more cautious about extending credit.
“Obviously there will be a little bit of tightening,” he said. “So I just see that as a kind of thumb on the scale. It just tightens financial conditions a bit and increases the likelihood of a recession.”
That view is echoed by economists on the Fed staff, who expected a “mild recession to begin later this year,” according to the minutes of the March 21-22 central bank meeting, released this month. Citing the fallout from the banking sector woes, Fed experts said the economy slowed faster than they had expected in January.
Their prediction of continued weakening was not enough to stop the Fed from raising rates again. Fed Chairman Jerome H. Powell has said higher credit costs will reduce pressure on prices by slowing business activity and reducing labor demand.
The Fed raised interest rates from nearly zero to nearly 5 percent last year, the fastest move since the early 1980s. So far, the job market has been resilient, with more than 1 million new jobs added in the past three months and unemployment among African Americans hitting an all-time low.
But as the full effects of higher interest rates begin to be felt, workers will pay the price. Construction employment – one of the sectors most sensitive to credit costs – fell last month for the first time since the end of 2021.
The Fed expects the unemployment rate to rise from 3.5 percent to 4.6 percent in the coming year. Some economists fear the Fed will overdo its monetary tightening just as more Americans are beginning to reap the benefits of a full-employment economy.
“If we get into a recession, it’s the Fed’s fault,” said William Spriggs, chief economist for the AFL-CIO. “There is nothing else on the horizon that will give us a recession.”
The economy shrugged off previous bouts of weakness, including in 2022, when it contracted for two consecutive quarters to open the year. New jobs continued to abound during that period and growth quickly resumed.
Similarly, some companies remain bullish even as analysts lower their expectations for corporate earnings this year. At Delta Air Lines, executives told investors last week they expect strong consumer demand this summer.
“We are seeing strength in all of our core hubs,” said Glen Hauenstein, Delta president.
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Economists at Goldman Sachs said Friday they see only a 35 percent chance of a recession in the next 12 months. The most recent inflation report — which shows prices rising at a 5 percent annual rate — means the Fed will likely raise interest rates at its May meeting and then pause, the bank said.
While the economy has endured a global pandemic, war in Europe and the highest inflation in 40 years over the past three years, forecasts often fall short.
But so far this year, the stock market has been largely unfazed by recession fears. The S&P 500 index gained more than 7 percent.
Biden administration officials also insist the economy is not weakening. In public appearances this month, officials said the banking system remained healthy after the bankruptcy of Silicon Valley Bank; inflation cools; and the job market is strong.
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The Federal Reserve Bank of Atlanta real-time tracker estimates first-quarter annualized growth at 2.5 percent.
“Recent economic indicators do not reflect a recession or even a pre-recession,” White House press secretary Karine Jean-Pierre said Thursday.
However, the bond market is issuing a warning. Short-term bonds offer investors a higher yield or interest rate than long-term securities, suggesting that investors are anticipating an eventual recession.
Friday’s report on the country’s factories also reflected a weakening. Industrial production fell by 0.5 percent in March compared to February, with car factories particularly hard hit. The dip suggests U.S. manufacturing has gained little from China’s reopening, Capital Economics said in a client note.
The performance of the economy for the rest of this year depends on two players: the consumer and the banks.
Consumer spending accounts for nearly 70 percent of the economy. For much of the pandemic, stay-at-home Americans spent money on purchases of electronics, furniture, clothing and other goods. As the country reopened to businesses, they began spending more of their money on personal experiences, such as dining at restaurants and going to movie theaters.
According to Daco’s estimate, government stimulus payments initially enabled consumers to accrue $2.4 trillion in above-average savings. That pile of excess cash is now down to about $1.4 trillion and the share of consumers who are past due on their credit cards is rising, meaning the end of the consumption boom is approaching.
When exactly it will arrive is unclear. Despite the headwind, consumers have more money in their pocket due to the improving labor market. Inflation-adjusted disposable income has risen for eight consecutive months, the best performance in nearly five years.
“A recession is far from inevitable,” said Jason Furman, President Barack Obama’s chief economic adviser. “In the US, real incomes are growing even as consumers run out of savings. Labor incomes are rising in a way that can support consumption.”
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The big concern now is how banks respond to the turmoil that rocked the industry following the collapse of SVB on March 10, followed two days later by the bankruptcy of another medium-sized institution, Signature Bank of New York.
Worst fears of an unchecked financial contagion have subsided. The rush of savers to move their money from banks of similar size to one of the industry giants, such as JPMorgan Chase or Citigroup, has eased. And bank demand for Fed emergency loans fell for the fourth week in a row as concerns about broader problems eased.
The economic damage from the bank’s missteps may well turn out to be greater.
Even before the crisis broke out, lenders began to tighten their credit conditions. In the weeks following the bankruptcies, commercial banks scaled back lending.
Commercial lending has fallen by more than $94 billion in the past three weeks, according to Fed data. Much of that reflects a change in accounting related to the seizure of the bankrupt institutions by the Federal Deposit Insurance Corporation. But about $34 billion probably reflects an actual decline in lending.
Small businesses are already feeling the first pressure of the credit crisis. In March, 9 percent of business owners said loans were harder to get, the highest figure in years, according to the National Federation of Independent Business. Credit is available, but at interest rates around 8 percent.
Some tightening by banks would help the Fed fight inflation. But if banks tighten too much, economic growth could slump.
Investors expect the Fed to raise rates at its May meeting and then stop. The magnitude of an emerging credit crisis can determine whether the market is correct.