Federal Reserve economists predict that turmoil after the collapse of several banks will cause a “mild recession” later this year, according to minutes of the Fed’s March meeting.
That forecast has led Fed officials to envision fewer interest-rate increases this year, out of concern that banks will reduce their lending and weaken the economy. The uncertainty in the banking sector also helped Fed officials coalesce around their decision to raise their key interest rate by just 0.25 percentage point, rather than a half-point, despite signs that inflation was still too hot, the minutes reveal.
The minutes, released Wednesday afternoon, note that the Fed’s prediction of a recession depends on how severe the banking industry’s troubles prove to be and to what extent they will cause a cutback in lending.
Before the collapse of Silicon Valley Bank, many officials said they had expected to raise rates several more times this year. Instead, Fed officials agreed that the collapse of the two large banks “would likely lead to some weakening of credit conditions,” as banks sought to preserve capital by curtailing lending to consumers and businesses.
“[T]he FOMC minutes finally showed some signs of a difference of opinions on the path forward for monetary policy, ” Jason England, global bonds portfolio manager at Janus Henderson Investors, said in an emailed report, adding, “it appears like they are much closer to a pause than we thought prior to the bank turmoil in early March.”
Officials differ on hikes
Several officials said they had considered supporting leaving rates unchanged at last month’s meeting. But they added that actions by the Fed, the Treasury Department and the Federal Deposit Insurance Corp. to protect depositors had “helped calm conditions” in banking and reduced the risks to the economy in the short run.
Some other officials said they had favored a half-point hike last month because hiring, consumer spending, and inflation data still pointed to a hot economy. But given the uncertainty resulting from the banking troubles, they “judged it prudent” to implement a smaller quarter-point increase.
Stocks fell Wednesday on the report’s warning of a possible recession and the latest update on inflation, which is still well above the Federal Reserve’s comfort level. The S&P 500 lost 15 points, or 0.4%, to close at 4,093 after bouncing between small gains and losses throughout the day. The Nasdaq composite slid 0.9% and the Dow also fell.
High rates can undercut inflation, but only by bluntly slowing the entire economy. That raises the risk of a recession, while hurting prices for stocks, bonds and other investments in the meantime, as well as lowering employment. The Fed has already raised rates at a furious pace over the last year, enough so that it hurt pockets of the economy and created strains within the banking system.Â
“The Fed has every reason to take a pause and only a handful of reasons not to,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments.
The bond market has been showing more nervousness about a potential recession, and traders have built bets that the Fed will have to cut interest rates later this year in order to prop up the economy.
