SUMMARY
The banking system is fundamentally stronger and better managed than it was in the crisis of 2008-09. Nonetheless, banks face increasing depositor and market scrutiny intensified by the ambiguous comments from regulators and policy makers.
- Most, but not all, developed market banks are both well-capitalized and have strong access to liquidity.
- To understand the likely economic impacts from recent events, we make a few key observations about the overall stability of banks in developed markets and the fact that the budding financial distress stems, in part, from the painful interest rate shock the Fed delivered to the US economy.
- We believe the US economy is positioned for a shallow recession. Owing to a historically mild period of growth in employment since Covid hit in 2020, we would expect the US unemployment rate to rise two percentage points from its recent low over the course of 2023-2024.
- We still disagree with economists who think non-financial businesses and labor markets will come out of 2023’s financial turmoil unscathed. The US economy was already slowing before the unexpected failure of two US banks. We believe that already weak and vulnerable industries – particularly those dependent on bank lending – will be more impacted than previously expected.
- With less credit available from banks, real estate industry weakness will only accelerate. Commercial real estate defaults are likely to balloon from present low levels as small and midsize banks shy away from extending new credit or restructuring old loans. But we don’t think this sector-level weakness portends a deep recession.
- How soon the Fed will ease monetary policy depends on the timing of job losses, but also financial developments that will drive the employment outlook. In the absence of a wave of further bank issues, we don’t think the Fed will unwind the past year’s tightening quickly. A weakening labor market and softening inflation could mean the Fed begins easing by late 2023.
- Non-financial shares have never avoided following banking shares into a correction.
