16 Mar 2023 3 min read

The Late Late Show

By Tim Drayson

Recent events suggest this cycle is approaching its denouement, even if it remains uncertain how much more, if any, monetary tightening will be necessary to curb inflation.


Unlike James Corden’s long-running US talk show, there is no fixed end date for this cycle. But the sirens are blaring loudly and suggest we are very late. The market narrative has swung from recession fears in October, to soft landing hopes at the start of this year, to no landing worries more recently and there are now concerns about a banking crisis. This could be the catalyst for recession.

For the first two months of this year, the US had proven remarkably resilient to rate hikes, especially in relation to the still incredibly strong labour market. Consensus was becoming more optimistic about growth and markets were wondering how high the US Federal Reserve (Fed) would need to raise rates before something broke. We now know the answer.

It remains to be seen whether the new Fed lending facility prevents further bank failures. But there is still likely to be a real economy effect. Silicon Valley Bank (SVB) was the 16th largest bank in the US. All the banks smaller than this account for around one third of US bank assets and lending. These banks should anticipate increased capital and regulatory costs at the same time as deposit outflows to larger banks. This will likely lead to a tightening in lending standards beyond what we have seen thus far, which was already flashing a heightened recession risk on our dashboard.


The Fed’s dilemma

Market pricing for future Fed policy has been volatile in recent days with markets jumping to the crisis playbook of rate cuts. But recent inflation news has also been problematic with stubbornly high services inflation. The Fed thought at the February FOMC that core inflation had decelerated in the three months to December to 3.1% annualised.

The seasonal adjustment factors were then revised up, followed by strong prints in January and February, leaving the latest reading at 5.2%. The median or trimmed mean CPI is showing even greater concern. The Fed is now walking a tightrope between financial stability and inflation. But even if the immediate panic subsides, tighter lending standards should mean the Fed does not need to reach as high a peak in rates as Powell’s recent semi-annual testimony had suggested.


Let’s not get too cute

Timing a recession is difficult. We’ve had a view for some time that it would begin gradually in the spring and then intensify in the second half of the year. Yet we also know that recessions are typically marked by discontinuities and a collective loss of confidence. Recent events suggest we should stick with our recession forecasts even if we are very unsure about the path for rates after the aggressive repricing lower.

Did I mention the debt ceiling?

The other consequence of recession starting soon is that the debt ceiling X- date could be brought forward from the Washington consensus for August. Revenues appear to already be disappointing and April tax collections will be crucial. While the pressure of a timeline is necessary to focus the mind of Congress, an earlier X-date increases the chance the political process fails to take the multiple steps necessary to raise the debt ceiling. It seems likely that market volatility is here to stay – for the time being at least.


Tim Drayson

Head of Economics

Tim keeps a close watch on global economic developments, with a particular focus on the US. He believes nothing good ever happens after midnight, which is why he is rarely spotted out late. Tim joined in 2008 from the number-one ranked economics team at ABN AMRO, with prior experience from HM Treasury, and graduated with a MSc from the University of Nottingham. When not crunching economic data, he can be found studying the weather forecast, analysing his cycling statistics or looking anxious on three-foot putts.

Tim Drayson