- The banking fiasco has heightened the risk of a recession, according to Pimco.
- Rattled lenders could tighten their balance sheets and fuel a credit crunch, the bond giant warned.
- “Recent events will likely lead to a mild recession in the case of the US,” strategists said Tuesday.
The risk of a US recession has increased because the banking turmoil will likely trigger a credit crunch, according to Pimco.
The fixed-income investing giant warned Tuesday that the collapse of SVB and Signature Bank in March and the volatility that followed will spur lenders to trim their balance sheets by offering fewer loans – potentially causing a slowdown in spending and investments, leading to an economic slump.
“Bank failures, wider elevated volatility in bank stocks, rising cost of capital, and ongoing potential for deposit flight from more fragile small and midsize US banks raise the prospect of a significant tightening of credit conditions… and therefore the risk of a sooner and deeper recession,” Pimco strategists Tiffany Wilding and Andrew Balls said in a research note.
SVB collapsed last month after massive losses on its bond holdings led to customers like Peter Thiel’s Founders Fund pulling their deposits – and its failure rattled bank stocks across the world.
In Europe, Credit Suisse was taken over by longtime rival UBS in a government-brokered rescue deal, while Deutsche Bank‘s share price cratered last month as investors demanded a higher premium on contracts that offer protection against the risk of a debt default by the lender.
“Recent events will likely lead to a mild recession, in the case of the US, and act as yet another headwind that could very well pull Europe into recession as well,” Pimco said.
The fact that so-called national champion banks with strict capital requirements are struggling means that “the risk of a deeper recession has surely gone up,” the strategists added.
Many investors are hopeful that the turmoil has driven up the likelihood of a Federal Reserve pause – where the central bank eases up on its interest-rate hikes to support the economy and prop up stock market valuations.
But it’s still unlikely that the Fed will cut borrowing costs anytime soon with inflation still running way clear of its 2% target – and that policy shift would likely be the only thing that could prevent a recession in the US, Pimco warned.
“Given still-high inflation, elevated government debt, and a widespread belief that the pandemic response caused the current inflationary environment, additional bank stress and rising recessionary risks are unlikely to be met with another large fiscal response, unless the economic implications are clear and severe,” Wilding and Balls said.
“Policy responses are likely to be lagged and less aggressive,” they added.