US recession is ‘very likely’

Oksana Patron

30 May 2023

A combination of tight monetary policy and the recent US banking crisis, led by its regional banks, has strengthen the probability that the US economy is close to enter recession, according to Brandywine Global, part of Franklin Templeton.

However, there was still sizable contingent who believed that a soft landing remains possible.

“I am not in that camp. The exact timing of when a potential recession might begin is lacking, but a fledgling U.S. banking crisis may have shortened the timetable. Let us look at where we are in the business cycle and see if there are any recessionary signals,” Brandywine’s J. Patrick Bradley, senior vice president – investment research, said.

Although some experts may believe that the US banking crisis caused by failures of three of its regional banks could be soon over, given the JP Morgan’s decision to purchase First Republic’s deposits and assets, Bradley said he remained ‘less assured’.

“The Fed appears to be staying the course on its rate-hiking path, putting banks and other interest-rate sensitive sectors under further strain. These potent ingredients of the Fed’s earlier hikes and recent bank failures suggest recession is likely baked into the mix,” he noted.

On top of that, small businesses who are the vital and integral to the US economy and rely on bank financing to a large extent, began to report concerns around credit availability, which is often seen as “evident in an economy experiencing a recession”, especially given that in the post-Great Financial Crisis (GFC) environment, credit availability was not a small business concern as fewer respondents specified credit availability as a business constraint following the GFC.

Also, the level of the leading indicators, which often provide a warning sign of pending economic deterioration and include measures like real money supply, building permits or the yield curve, has fallen more than three months in a row, and the index has declined nearly 8% over the past year, meaning that “leading indicators are flashing a bright, red recession warning”.

According to Bradley, there was also a probability that more banks could fail as market lacked confidence  that the financial crisis was over.

“Tight monetary policy and failing banks suggest a U.S. recession is baked in. The U.S. economy is slowing; financial stress is evident; credit availability is constrained by the banking failures—and likely to tighten further; leading indicators are falling; and the probability of a recession, according to some analyses, is rising,” he added.

“Whether or not the Fed quickly reverses the direction of its policy will not alter my expectation of a recession. Monetary policy operates with long and variable lags, with an emphasis on long. More banks could fail.