Acute bank stress will prompt a further tightening in credit conditions, which leaves us even more convinced that the economy will fall into recession this year. With core inflation remaining stickier than we had originally expected, however, the Fed probably won’t begin cutting its policy rate until September. Furthermore, while we would still describe our baseline scenario as a softish landing, since the peak-to-trough fall in GDP is less than 1% and the unemployment rate peaks at a modest 5%, the downside risk of a much harder landing is rising. We are most concerned that an adverse feedback loop will develop between small banks and commercial real estate, triggering an even bigger credit tightening.
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