Hopes that the U.S. could escape a recession seemed to be dashed earlier in March with the two biggest banking failures since 2008. But the financial system has so far held firm, and in the long run, the trauma of the banking collapses may even help return the economy to growth and lift the stock market.
The S&P 500 has been mired in bear market territory since last year, weighed down by nine interest rate hikes to combat inflation and the recent banking crisis. But the failures of Silicon Valley Bank and Signature Bank this month could make the Federal Reserve stop its interest rate hikes, and possibly spark a 14% rally in stocks by year’s end, according to Ed Yardeni, president of Yardeni Research and long-time investment strategist.
“The financial crisis we’ve had here—this banking crisis—is going to be very well contained by both the Fed and the FDIC,” Yardeni said in an interview with CNBC Wednesday. “And at the same time, I think it’s going to keep the Fed from raising interest rates even further.”
If the Fed paused interest rate hikes now, by the end of the year the S&P 500 could hit 4600 points, up from 4046 points at market open Thursday, Yardeni said.
The Federal Reserve’s abrupt shift from a near-zero interest rate environment to a high one over the past year played an important role in SVB’s collapse. Before it was brought down by a classic bank run, SVB faced a possible liquidity crisis, while high rates also hit many of the bank’s clients, mainly tech startups and venture capital firms, that suddenly had a much harder time accessing capital.
At its March 22 meeting, the Fed defied investors who called to pause in rate hikes and announced the smallest increase since a year earlier, when the central bank’s tightening cycle began. Fed officials signaled last week that it wouldn’t be the last rate hike of the current cycle, but the central bank’s last rate increase may be in sight.
“I don’t see the Fed lowering interest rates, but I think they are currently at a restrictive enough level where they don’t have to keep raising interest rates,” Yardeni said.
The Fed has certainly signaled a willingness to slow down amid the banking crisis and scathing critiques by policymakers. In addition to the March rate hike, which was lower than some had predicted before the banking crisis, the Fed may also reduce the number of rate hikes it will approve this year. Most Fed officials seem to be planning for one more rate hike in 2023, while last month analysts had forecasted three increases this year, including one in March.
Some analysts and observers share Yardeni’s view that the banking crisis could help cool the economy. In effect, it could accomplish what the Fed is trying to do through its interest rate hikes, as bank failures tend to make the surviving banks more careful about lending. Last week, Fed Chair Jerome Powell said the crisis could create “tighter credit conditions” that could depress economic activity and indirectly help reduce inflation.
But slowed economic activity is exactly what the Fed wants, and may help the central bank’s efforts to reduce inflation, Goldman analysts led by chief economist Jan Hatzius wrote in a research note this week. Reduced lending “will prove to be a headwind” to the economy and help the Fed in its efforts to slow the economy but “not a hurricane that pushes the economy into recession,” he wrote.
But if banks reduce lending too much, it risks tipping the economy into a recession. A “sudden stop” to lending remains a “sizable risk,” AXA Investment Managers chief economist Gilles Moec told Reuters this week, citing high levels of borrowing from banks as evidence. And even if lending only slows slightly, it would still deal a huge blow to more vulnerable parts of the economy that lack cash reserves, such as small businesses.
Much will depend on whether the troubles at smaller banks spread to big ones too. But Hatzius expects larger banks to continue lending due to “higher capital and liquidity standards than smaller banks” that make them more stable.
Yardeni also told CNBC that stocks and the economy have so far been able to resist the impact of higher interest rates and evaporating capital, suggesting it’s a sign they would also survive a decline in lending. “I don’t think we’re looking at an economy-wide credit crunch,” he said. “I think we’ve already seen a lot of bubbles burst without taking the economy down.”