Recession risks rise for Biden and Democrats

Other midsize banks including PacWest, Western Alliance and Zions came under heavy investor pressure late last week as Wall street probed for possible next victims in the rolling crisis, created in part by the Fed jacking up interest rates ten consecutive times to the highest level since 2007. The Fed bumped up rates another quarter point last week but suggested it could possibly pause the hikes at its next meeting in June.

The rate increases helped tamp down a historic rise in consumer inflation in the wake of the Covid pandemic. But prices are still rising significantly faster than the Fed’s target of around 2 percent per year.

The April employment report released on Friday, showing a still remarkably healthy 253,000 new jobs created, also showed wage increases bumping up to a 4.4 percent annual pace from 4.3 percent. The Fed is eager to see wage increases cool because they can feed into overall inflation as companies pass higher employment costs on to consumers in the form of higher prices.

Shares in regional banks that got slammed late last week recovered somewhat over the last two trading sessions. And each bank has depositor profiles very different from the three failed lenders, which had much higher levels of accounts with above the FDIC insured threshold of $250,000.

Still, there remains heavy concern across Wall Street and among many economists that the Fed’s rapid and intense campaign of rate hikes meant to battle inflation will smash the brakes on the economy hard enough to create a recession.

Such a recession would come as Biden, who continues to suffer from very low approval ratings especially on the economy, is just launching his reelection effort. Republicans are poised to rip the incumbent and Congressional Democrats, arguing their heavy spending policies in the wake of Covid helped drive up inflation. The White House is also facing a possibly market-shaking showdown with Hill Republicans on the nation’s borrowing limit.

All the rate hikes are only just now beginning to ripple across the economy, driving down the homebuilding and other sectors as borrowing costs make it much more difficult for consumers to make big purchases and businesses to make major investments. That impact showed up in the survey released on Monday, officially known as the Federal Reserve Senior Loan Officer Survey or “SLOOS.” The report, while not as dire as some feared, showed that the banking sector meltdown is causing lenders to tighten up even further.

“Banks most frequently cited an expected deterioration in the credit quality of their loan portfolios and in customers’ collateral values, a reduction in risk tolerance, and concerns about bank funding costs, bank liquidity position, and deposit outflows as reasons for expecting to tighten lending standards over the rest of 2023,” the report said.

The Fed in a separate report Monday cited a potential contraction in lending triggered by bank stress as one of the financial system’s top near-term risks. Businesses would feel the brunt of the impact.

“A sharp contraction in the availability of credit would drive up the cost of funding for businesses and households, potentially resulting in a slowdown in economic activity,” Fed officials said in the report. “With a decline in profits of nonfinancial businesses, financial stress and defaults at some firms could increase, especially in light of the generally high level of leverage in that sector.”

Many economists — including Democrats like former Treasury Secretary Larry Summers — argue that all the hikes will eventually cause at least a brief recession that drives the jobless rate higher, knocking out a key pillar of Biden’s pitch for a second term. The economy expanded at just a 1.1 percent pace in the first quarter of the year, according to an initial government estimate. And many economists now see significant odds of a recession starting later this year and possibly dragging into the 2024 campaign year.

“The Federal Reserve Senior Loan Officer Survey provides the first real insight into how much lending has tightened on the back of turmoil among local and regional banks,” said Joseph Brusuelas, chief economist at consulting firm RSM US. “While banks have been tightening lending standards for the past year, the jump in the percentage of those reporting further tightening does denote an increase in the risk of a hard economic landing.”