When the Federal Reserve is raising rates, an unexpected shock can trigger a recession.
Take a tour through US recessions of the past 50 years, and it’s hard not to wonder whether Silicon Valley Bank will turn out to be the banana peel that upends an already unsteady economy.
When the Federal Reserve is raising interest rates, as it is now, recession is always a risk. And slumps tend to come suddenly after an unexpected shock deals a blow to confidence during a particularly vulnerable time.
“The combination of the Federal Reserve trying to slow things down to deal with inflation, financial conditions tightening and then—under the stress—you’re going to see some breakage,” says Peter Hooper, global head of economic research for Deutsche Bank AG.
Sometimes an external blow tips over a slowing economy, as in 1990 when oil prices spiked in reaction to Iraq’s invasion of Kuwait, spoiling former Fed Chair Alan Greenspan’s hopes for a soft landing.
More often, higher rates reveal hidden weaknesses, especially after a period of easy money or an influx of financial sector deregulation. Sectors that are over-leveraged, investment funds with heavily concentrated exposure or banks with too much risk get exposed as the proverbial naked swimmers when the tide goes out.
In the early 1980s, Fed Chair Paul Volcker was waging his now-legendary fight against inflation. It triggered the collapse of Continental Illinois National Bank & Trust Co., then the seventh-largest commercial bank in the US.
Here are two more instances in which a series of Fed rate hikes exposed cracks that widened into a full-fledged downturn. The bursting of the so-called dot-com bubble in 2001 set off a recession; seven years later, an over-leveraged housing sector brought down Bear Stearns and Lehman Brothers. In each case, a rapid series of events turned wariness over slowing growth into more visceral fear of what might happen next. Investors and lenders across the economy withdrew to safety, consumers retrenched and employers began cutting workers loose.
“There is a fragility in the US macro economy that is not well understood but is plainly evident to the naked eye when growth slows to a walking speed,” says David Wilcox, director of US economic research at Bloomberg Economics and a former division director at the Fed.
What’s easy to see, Wilcox says, is that when confidence takes a sudden downturn, unemployment tends to ramp up shar