Pick Your Poison
The U.S. economy is at an interesting point.
In the past week or so, there were three bank closures in Silvergate bank, Silicon Valley bank, and Signature Bank. These closures have investors fearing that more bank closures could be on the way.
On the other hand, jobs are still plentiful and the federal reserve continues to fight high inflation, which is a result of high demand for goods and services.
Let’s walk through two scenarios on where the U.S. economy could head next.
The Bank Closures Are Systematic
A systematic risk is a risk that can hurt the entire economy.
In this scenario, the risk to the economy is not limited to the banks mentioned above and can be spread to other institutions. This will cause a ripple effect throughout the financial system.
If this turns out to be true, the federal reserve may have to take a step back from raising rates, because in this scenario, a recession has most likely already occurred. So, raising rates will only exacerbate the situation. Therefore, expect lower rates, but a damaged economy. Following a damaged economy will potentially be lower demand for goods and services, and therefore, disinflation.
The Bank Closures Are Unsystematic
An unsystematic risk is a risk that is limited to one section of the economy.
In this scenario, the risk to the economy is limited to a select few banks that engaged in more speculative activity, such as funding startups and crypto companies. The rest of the financial system is in tact and consumers are not fearful.
If this turns out to be true, the federal reserve will turn its attention back to the seemingly never-ending battle of inflation. In January, inflation rose 0.5% month-over-month and is still up 6.4% from a year ago. So, expect higher rates which can cause further damage to the economy down the road.
Both scenarios seem like a losing proposition for the economy. Although this doesn’t have to be a binary situation, where the economy heads next will likely be a version of one of these two scenarios.
So, pick your poison.