Economy stumbled after banking crisis, stirring renewed recession fears
But throughout the recovery from the coronavirus pandemic, the $26 trillion U.S. economy has defied the odds, minting new jobs at a remarkable pace and avoiding the oft-predicted downturn. Like a prizefighter absorbing a punch, it may yet recover its balance and persevere.
The news on Friday, however, was not great. Retail sales fell for the second straight month, as Americans bought fewer cars, clothes and pieces of furniture. Manufacturing output dipped. And commercial bank lending rose only slightly after two weeks of declines. New business loans in March increased by just $30 billion, the smallest monthly gain since mid-2021, when the pandemic was gathering force, according to the Federal Reserve.
“I think it’s increasingly likely we’ll end up with some form of recession,” said Gregory Daco, chief economist at EY Parthenon. “We’re seeing more and more evidence of a slowdown in economic activity.”
Aftershocks from the recent banking turmoil make a recession more likely, Jamie Dimon, chief executive of JPMorgan Chase, the nation’s largest bank, told analysts Friday. The sudden failure of two U.S. banks and the takeover by a European rival of Credit Suisse, a global titan, left other institutions more cautious about extending credit.
“Obviously, there’s going to be a little bit of tightening,” he said. “So I just look at that as a kind of a thumb on the scale. It just makes the finance conditions be a little bit tighter, increases the odds of a recession.”
That view is shared by Fed staff economists, who anticipated a “mild recession starting later this year,” according to minutes of the central bank’s March 21-22 meeting, which were released this month. Citing fallout from banking industry woes, Fed experts said the economy was slowing faster than they had anticipated in January.
Their forecast of continued softening was not enough to keep the Fed from raising interest rates again. Fed Chair Jerome H. Powell has said higher credit costs will reduce the pressure on prices by slowing business activity and cutting demand for labor.
The Fed has raised rates over the past year from near zero to almost 5 percent, its fastest such move since the early 1980s. So far, the labor market has been resilient, adding more than 1 million new jobs over the past three months and driving unemployment among African Americans to a historic low.
But as the full effects of higher interest rates make themselves felt, workers will pay the price. Employment in construction — among the industries most sensitive to credit costs — fell last month for the first time since the end of 2021.
Over the next year, the Fed anticipates the unemployment rate rising to 4.6 percent from the current 3.5 percent. Some economists worry the Fed will overdo its monetary tightening, just as more Americans are starting to enjoy the benefits of a full-employment economy.
“If we get a recession, it is the Fed’s fault,” said William Spriggs, chief economist for the AFL-CIO. “There is nothing else on the horizon that gets us a recession.”
The economy has shrugged off earlier bouts of weakness, including in 2022 when it shrank for two consecutive quarters to open the year. New jobs remained abundant during that period and growth swiftly resumed.
Likewise, even as analysts mark down their expectations for corporate earnings this year, some businesses remain upbeat. At Delta Air Lines, executives told investors last week that they anticipate strong consumer travel demand this summer.
“We see strength in all of our core hubs,” said Glen Hauenstein, Delta’s president.
Economists at Goldman Sachs said Friday that they see just a 35 percent chance of recession in the next 12 months. The latest inflation report — showing prices rising at a 5 percent annual pace — means the Fed will probably raise interest rates at its May meeting and then pause, the bank said.
For the past three years, as the economy has weathered a global pandemic, war in Europe and the highest inflation in 40 years, forecasts have often missed the mark.
But so far this year, the stock market has been largely unfazed by recession fears. The S&P 500 index has gained more than 7 percent.
Biden administration officials also insist the economy is not flagging. In public appearances this month, officials said the banking system remained sound in the wake of Silicon Valley Bank’s failure; inflation is cooling; and the labor market is strong.
The Federal Reserve Bank of Atlanta’s real-time tracker pegs first-quarter growth at an annual rate of 2.5 percent.
“Recent economic indicators are not consistent with a recession or even a prerecession,” White House press secretary Karine Jean-Pierre said on Thursday.
The bond market, however, has been flashing a warning. Short-term bonds offer investors a higher yield, or interest rate, than do longer-term securities, suggesting that investors anticipate an eventual recession.
Friday’s report card on the nation’s factories also reflected weakening. Manufacturing output in March dropped 0.5 percent from February, with motor vehicle factories particularly hard hit. The dip suggests that U.S. production has gained little from China’s reopening, Capital Economics said in a client note.
The economy’s performance for the rest of this year hinges on two players: the consumer and the banks.
Consumer spending accounts for nearly 70 percent of the economy. For much of the pandemic, Americans stuck at home splurged on purchases of electronics, furniture, clothes and other goods. As the nation reopened for businesses, they began devoting more of their money to in-person experiences, such as restaurant dining and visits to movie theaters.
At first, government stimulus payments enabled consumers to accumulate $2.4 trillion in above-trend savings, according to Daco’s estimate. That pile of excess cash now is down to about $1.4 trillion and the share of consumers who are delinquent on their credit cards is rising, meaning the end of the consumption boom is drawing near.
Just when it will arrive is unclear. Despite the head winds, consumers have more money in their pockets as a result of the strong labor market. Inflation-adjusted disposable income has increased for eight consecutive months, its best streak in almost five years.
“A recession is still very far from inevitable,” said Jason Furman, who was President Barack Obama’s top economic adviser. “In the U.S., real incomes actually are growing even as consumers run out of excess savings. Labor earnings are rising in a way that can support consumption.”
The big worry now is how banks react to the turmoil that convulsed the industry after the March 10 collapse of SVB, followed two days later by the failure of another midsize institution, Signature Bank of New York.
The worst fears of an unchecked financial contagion have eased. The rush by depositors’ to move their money from similarly sized banks to one of the industry’s giants, such as JPMorgan Chase or Citigroup, has tapered off. And bank demand for emergency Fed loans fell for the fourth straight week, as worries about broader problems eased.
The economic damage from the banks’ missteps could prove more consequential.
Even before the crisis erupted, lenders had begun tightening their credit standards. In the weeks since the failures, commercial banks have cut back on lending.
In the last three weeks, commercial loans fell by more than $94 billion, according to Fed data. Much of that reflects a bookkeeping change related to the Federal Deposit Insurance Corporation’s seizure of the failed institutions. But about $34 billion probably reflects an actual drop in lending.
Small businesses already are feeling the first squeeze from the credit crunch. In March, 9 percent of business owners said loans were harder to obtain, the highest figure in several 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 sink.
Investors expect the Fed to raise rates at its May meeting and then stop. The extent of any emerging credit crunch could determine whether the market is correct.