A Recession Could Come Sooner on Cooling Bank Lending

Wall Street has been debating whether the economy is heading into a recession for months. However, recent events have led many to believe that a contraction in the economy may come sooner than expected. The rapid market moves after the regional bank failures in the U.S. have some strategists predicting a downturn in the economy.

According to economists, the pullback in bank lending and plummeting bond yields are the main factors that could trigger a recession. In addition, the steep drops in oil and stock prices and a sharp jump in volatility also signal that investors fear a recession is now on the horizon.

What The Markets Say

Stocks have been down lately, with concerns about Credit Suisse spooking markets already concerned about U.S. regional banks following the closure of Silicon Valley Bank and Signature Bank.

“What you’re seeing is a significant tightening of financial conditions. What the markets are saying is this increases risks of a recession, and rightfully so,” said Jim Caron, head of the macro strategy for global fixed income at Morgan Stanley Investment Management.

Bond yields came off their lows, and stocks recovered some ground in afternoon trading following reports that Swiss authorities were discussing options to stabilize Credit Suisse.

The Effect on Banks and the Economy

According to JP Morgan economists, the pullback in bank lending and tighter monetary policy could subtract a half to a full percentage point off the level of GDP over the next year or two.

“We believe this is broadly consistent with our view that tighter monetary policy will push the U.S. into recession later this year,” JP Morgan economists wrote.

After a one-day snapback, Bank stocks led the market’s decline, with First Republic down 21% and PacWest down nearly 13%. The energy was the worst-performing sector, down 5.4% as oil prices plunged more than 5%. West Texas Intermediate futures settled at $67.61 per barrel, the lowest level since December 2021.

At the same time, the Cboe Volatility Index, known as the VIX, rocketed to a high of 29.91 on Wednesday before closing at 26.10, up 10%.

Key Takeaway

Wall Street’s debate about whether a recession is coming has been ongoing. However, recent news about the cooling of bank lending and plummeting bond yields have signaled that a downturn may be on the way. With bank stocks leading the market’s decline, the economy could suffer significant consequences if tighter monetary policies and reduced lending lead to a recession.

Related Facts

• Wall Street has been debating the possibility of a recession for months.
• According to JP Morgan economists, the pullback in bank lending could subtract from GDP.
• The Cboe Volatility Index, the VIX, has recently rocketed, indicating investor fears of a recession.

Conclusion

The recent cooling of bank lending has many on Wall Street predicting an economic downturn. If the trend continues, we could see the economy contract sooner rather than later. It remains to be seen how policymakers will react and what measures they will take to prevent a recession from taking hold.