US Banking Crisis May Trigger Recession Later This Year, Says Federal Reserve

Federal Reserve documents released on Wednesday have indicated that fallout from the U.S. banking crisis is likely to cause the economy to tilt into recession later this year. The documents, which include minutes from the March meeting of the Federal Open Market Committee, revealed that staff economists projected a mild recession starting later this year, with a recovery over the subsequent two years, due to potential repercussions from the failure of Silicon Valley Bank and other financial sector tumults.

The banking sector was described as “sound and resilient” by Vice Chair for Supervision Michael Barr, but projections from Fed officials showed gross domestic product growth of just 0.4% for all of 2023. Atlanta Fed tracking a first-quarter gain of around 2.2% would indicate a pullback later in the year. The Fed has had to create emergency lending facilities to ensure banks could continue operations following the collapse of Silicon Valley Bank, the 17th largest institution in the US, and two others.

FOMC officials ultimately voted to increase the benchmark borrowing rate by 0.25 percentage points, bringing the fed funds rate to a target range of 4.75%-5%, its highest level since late 2007. The rate hike came less than two weeks after Silicon Valley Bank’s collapse following a run on deposits.

However, several policymakers questioned whether to hold rates steady as they watched to see how the crisis unfolded. They relented and agreed to vote for another rate hike “because of elevated inflation, the strength of the recent economic data, and their commitment to bring inflation down to the Committee’s 2 percent longer-run goal.” In fact, the minutes noted that some members were leaning toward a half-point rate rise prior to the banking problems. Officials said inflation is “much too high” though they stressed that incoming data and the impact of the hikes will have to be considered when formulating policy ahead.

Though inflation data has been generally cooperative with the Fed’s aims, a monthly survey from the New York Fed showed that inflation expectations over the next year increased half a percentage point to 4.75% in March. The personal consumption expenditures price index, which is the inflation gauge policymakers watch the most, increased just 0.3% in February and was up 4.6% on an annual basis.

Earlier Wednesday, the consumer price index showed a rise of just 0.1% in March and decelerated to a 5% annual pace, the latter figure down a full percentage point from February. However, that headline CPI reading was held back mostly by tame food and energy prices, and a boost in shelter costs drove core inflation higher by 0.4% for the month and 5.6% from a year ago, slightly above where it was in February. The Fed expects housing inflation to slow through the year.

Markets as of Wednesday afternoon were assigning about a 72% chance of one more quarter percentage point rate hike in May before a policy pivot where the Fed cuts before the end of the year, according to CME Group data. Though the FOMC approved an increase in March, it did alter language in the post-meeting statement, indicating that more hikes “may be appropriate” rather than “ongoing increases.”

The Fed’s concern over broader economic conditions remained high, particularly in light of the banking problems. Officials said they expect lending to tighten and credit conditions to deteriorate, even with the actions taken. The minutes noted that the programs helped get the industry through its troubles, but participants recognized that there was significant uncertainty as to how those conditions would evolve.

The staff’s projection of a mild recession starting later this year raises concerns about the economy’s future. The Fed has been focused on keeping inflation down.