What Current Economic Jitters Mean for Banks

So much for August being a slow news month: Recent economic developments have everyone on high alert and thrown the markets for a loop. After we learned that the jobless rate climbed to a disappointing (but still historically low) 4.3% in July, the highest since late 2021, the markets swooned—stirring concerns about the U.S. economy’s trajectory and bringing fears of a recession back to the fore. 

The unease is compounded by the Federal Reserve’s current stance on interest rates—cuts are coming, but some say not soon enough—and the broader impact on markets and investments. To make sense of it all, we reached John Silvia of Dynamic Economic Strategy, former chief economist for Wells Fargo. Here’s his take on the likelihood of a recession, the vulnerabilities banks need to watch out for, and how the Fed’s next moves could shape the economic landscape. 

Is a recession likely? Silvia puts the probability at 20%. To get a view on where we are headed, he said banks should closely monitor key indicators such as unemployment claims, consumer sentiment, capital goods orders and shipments, and the ISM indices for both manufacturing and services. The NFIB survey, reflecting small businesses’ hiring intentions, should also be on banks’ radar. But, he said, “watch next month’s jobs number.” A key Labor Department report, coming August 21, will provide a more comprehensive overview of employment. Silvia noted that July’s weak employment number was influenced by 436,000 workers sidelined by severe weather, specifically Hurricane Beryl in Texas. 

What banking areas are most vulnerable? “The problem is credit risk for small business and consumer loans,” Silvia said, pointing out that delinquency rates for credit cards with payments overdue by 90 days or more have surpassed their 2021 peak. Delinquency rates for auto loans among borrowers aged 18-29 and 30-39 are also above the 2021 peak. 

How would a downturn under these conditions affect banks? Silvia says banks could benefit, but it’s a “tough tradeoff.” On one hand, a related steep drop in interest rates could reduce funding and deposit pressures, potentially aiding net interest margin. But this benefit might be offset by a decline in lending business and spiking charge-off rates as borrowers find it harder to repay debts.  

How could a rate cut impact the value of bonds that banks hold? Silvia explained that lowering interest rates could positively affect the value of all bonds, thereby improving a banks’ financial position. Specifically, he noted that banks would not necessarily need a steep decline in interest rates to benefit. A decline of just 100 basis points could significantly help banks by increasing the value of bonds purchased at higher rates. Additionally, even low-interest bonds would become relatively more attractive as overall rates decrease. Silvia added that banks can already benefit from lower rates now in anticipation of the Fed easing, with further gains expected when the Fed does indeed lower rates. 

How will the Fed respond to current economic signals? Silvia anticipates that despite recent criticisms, the Fed will move slowly in adjusting interest rates. While some economists are anticipating greater movement, he believes the Fed will lower rates by 50-100 basis points over the next year, as inflation continues to moderate.