Evening Brief – 04.18.23

The Federal Reserve appears to be taking a lot of comfort in some of the recent high frequency data from the banks, including a reduction in the use of various emergency liquidity facilities implemented in the wake of the Silicon Valley Bank and Signature Bank collapses, and the fact that bank deposits bounced back a bit last week.

This may sound encouraging, but it’s probably a mistake to conclude that the ramifications of the regional bank fallout are over. We may be at the end of the acute phase of the banking crisis, but we are likely now in the chronic phase.

Perhaps, in baseball parlance, we are only in the 2nd or 3rd inning in terms of banks turning more cautious and tightening lending standards, which gradually evolves into a credit squeeze, in turn affecting SMEs and CRE as borrowers face higher debt service costs and refinancing becomes much harder to obtain.

The collapse of Silicon Valley Bank and other regional banks has put a microscope under many regional banks, and their CRE loan books remain a significant concern. According to JP Morgan data as of February, regional banks accounted for 70% of total CRE loans outstanding, excluding multifamily, farmland and construction loans.

That said, we shouldn’t take too much comfort in the real-time data as there is still a high probability of a sizable credit squeeze.

Meanwhile, if the market’s view about inflation continuing to decline is correct, which could occur faster than the central bank anticipates, and we are confronted with a mild recession brought on by a credit squeeze, then the central bank probably needs to pivot quickly to avoid a deeper economic downturn. As a result, the chances of several interest rate cuts by the end of the year are increasingly likely.