The latest turmoil in the banking sector could bring the United States closer to a recession, Minneapolis Fed President Neel Kashkari has warned.
“It definitely brings us closer,” Kashkari said. “What’s unclear for us is how much of these banking stresses are leading to a widespread credit crunch. That credit crunch ... would then slow down the economy. This is something we are monitoring very, very closely.”
“Now, on one hand, such strains could then bring down inflation. So we have to do less work with the federal funds rate to bring the economy into balance. But right now, it’s unclear how much of an imprint these banking stresses are going to have on the economy. But it’s something to watch very carefully. And that’s what we’re focused on,” Kashkari added.
Federal Reserve Chairman Jerome Powell said last week that the recent turbulence in the financial system following the collapse of two major U.S. banks has raised the chances that there will be further credit tightening for U.S. households and businesses.
A cutback in bank lending would result in less spending by both consumers and businesses and make it more difficult for companies to increase prices, reducing inflationary pressures.
‘Concerning Signs’
“Such a tightening in financial conditions would work in the same direction as rate tightening,” Powell told reporters during a press conference in Washington. “You can think of it as being the equivalent of a rate hike or perhaps more than that.”When asked on Sunday whether he would hit the brakes on interest rate hikes at the Fed’s next meeting in May, Kashkari noted that the stresses to the banking system are only a “couple of weeks old” and policymakers will still need to wait and see what the longer-term impacts are on the economy before making any decision.
The Minneapolis Fed president noted there are currently some “concerning signs” such as capital markets that have largely been closed for the past two weeks.
“If those capital markets remain closed, because borrowers and lenders remain nervous, then that would tell me, OK this is probably going to have a bigger impact on the economy,” he said. However, he noted that deposit outflows seem to have slowed, in a positive sign that some confidence is being restored among smaller and regional banks.
It’s too early to make any forecasts about the next interest rate meeting, he said, but the Federal Open Market Committee will be focused on those factors when it meets again.
Increased Risks to Global Financial Stability
Kashkari’s comments come after Luke Ellis, the CEO of one of the largest publicly traded hedge funds warned that the turmoil sparked by the collapse of SVB is not over and a “significant number” of banks could fail in the next two years.“At a time of higher debt levels, the rapid transition from a prolonged period of low-interest rates to much higher rates—necessary to fight inflation—inevitably generates stresses and vulnerabilities, as evidenced by recent developments in the banking sector in some advanced economies,” Georgieva told a conference in Beijing.
On the same day, Luis de Guindos, vice-president of the European Central Bank, also noted that the recent events could impact the euro area economy.
Despite his warning of a potential recession, Kashkari sought to reassure Americans of a “resilient” and “sound” banking system that has strong a capital position and plenty of liquidity, reiterating comments that have been repeatedly made by the Biden administration.
That poll found that just 10 percent of U.S. adults have high confidence in the nation’s banks and financial institutions, down from 22 percent in 2020, while 57 percent said they have some confidence in banks, and 30 percent have hardly any.
