But all has changed following the collapse of three US banks over a matter of days. The chief economist of Apollo Global Management now says he’s bracing for a hard landing. He joined the What Goes Up podcast to discuss his changing views.

Here are some highlights of the conversation, which have been condensed and edited for clarity. Click here to listen to the full podcast on the Terminal, or subscribe below on Apple Podcasts, Spotify or wherever you listen.

Q: You changed your view of seeing a no-landing scenario to a hard-landing one — tell us about this.

A: The debate up until recently was that, well, why is the economy not slowing down when the Fed is raising rates? Why is it that the consumer is still doing so well? And a very important answer to that was that, well, there was still a lot of savings left across the income distribution, that households still had plenty of savings left after the pandemic. And up until recently, the debate was why is this economy not slowing down? And call that what you want, but that’s what we have called the no landing. And that was the reason why inflation continued to be in the range of 5%, 6%, 7%. That’s why the Fed had to raise rates. 

What happened, of course, here with Silicon Valley Bank was that suddenly out of the blue, at least for financial markets, really nobody — and I think that’s safe to say at this point — had seen this coming.

And as a result of that, suddenly we all had to go back to our drawing boards and think about, OK, but what is the importance of the regional banks? What is the importance of the banking sector in terms of credit extension? In data from the Fed, you will see that roughly a third of assets in the US banking sector are in the small banks. And here a small bank is defined as bank number 26 to 8,000. A large bank is number one to 25 ranked by assets. So that means that there’s a long tail of banks. Some of them are fairly big, but the further you get out, the smaller they get. And the key question for markets today is, how important are the small banks that are now facing issues with deposits, with funding costs, facing issues with what that might mean for their credit books, and also facing issues with what does it mean if we now also have to do stress test on some of these smaller banks?

So this episode with the Silicon Valley Bank, markets are doing what they’re doing and there’s a lot of things going on, but what is really the major issue here is that we just don’t know now what is the behavioral change in terms of lending willingness in the regional banks. And given the regional banks make up 30% of assets and roughly 40% of all lending, that means that the banking sector has now such a significant share of banks that are now really at the moment thinking about what’s going on. And the risk with that is that the slowdown that was already underway — because of the Fed raising rates — might now come faster simply because of this banking situation. So that’s why I changed my view from saying no landing, everything is fine to now saying, well, wait a minute, there is a risk now that things could slow down faster because we just need to see over the coming weeks and months ahead, what is the response going to be in terms of lending from this fairly significant part of the banking sector that is now going through this turbulence we are seeing.

Q: We haven’t really seen any deterioration in creditworthiness yet. Will it play out in a similar fashion as far as curtailing the supply of credit? Or is there a reason to think it’ll be different? And is it possible we still have another shoe drop with the deterioration of credit quality going forward?

A: I started my career at the IMF in the 1990s, and the first thing you learn is that a banking crisis and a banking run normally happen because there are credit losses on the bank’s books. We saw that in 2008. If you go back to the 1990s, you saw that on the savings and loan crisis. And these were very illiquid losses. This couldn’t just be sold very quickly. That is very, very different. We have basically never had a banking crisis in a strong economy. And the irony of this situation is that it is actually the most liquid asset, namely Treasuries, that turned out to be the problem.

So that’s why if 10-year rates, let’s say that they go down to say, 2.5% or even 2%, that will be helping incredibly on the banks’ balance sheets because it is the liquid side of the balance sheets that have, at least in this episode, been the main problem in terms of what the issues are. So that’s why the fear is that if we now have not only the lagged effects of the Fed hiking rates already slowing the economy, but if you now have a magnified effect that the slowdown might come a bit faster, then of course we do ultimately also need to look at what does that mean for credit losses, for everything that banks have on their balance sheets.

Q: What everybody in the market is saying is that they were waiting for the moment the Fed “broke” something and now something has broken. So what are you expecting from the Fed meeting?

A: The challenge today, looking to the Fed meeting, is that there are some risks for the Fed to financial stability. If we had spoken about this a week ago, then I would’ve said they’re going to go 50. But today, it is suddenly the case that the top priority — which we thought until recently was all inflation — has been replaced and put into the back seat of the car. Now the top priority is financial stability. And when the top priority is financial stability, then the Fed needs to be absolutely sure that the financial system is stable and financial markets are calm, and that, therefore, that credit is flowing to consumers, to corporates, to residential real estate, commercial real estate, with the idea that if that is not the case, then you are at risk of having obviously a much harder landing. So that’s why financial stability being the top risk would lead me to the conclusion that they can always raise rates later if this does turn out to be like Orange County and LTCM. But at the moment, the biggest risk going into this meeting is certainly that the financial system needs to be stable for them to feel comfortable before they can begin to even think about raising rates again.

— With assistance by Stacey Wong