Big U.S. Banks pass the Fed’s annual stress test

FS Insight Team

This week, amid concerns that central bankers could send the global economy into a recession, we learned that the 33 largest banks in the U.S. passed the Federal Reserve’s annual stress test. The test scenario included a 40% decline in commercial real estate prices, a 55% drop in stock prices, higher stress in the corporate debt market, and a 10% unemployment rate. All told, the results endorse the strength of U.S. banks. Stricter capital requirements and other Dodd-Frank financial regulations have forced banks to clean up their balance sheets and manage risk more responsibility.

Also, this week, Federal Reserve Chairman Jerome Powell reiterated that the Fed was “strongly committed” to higher rates, which he thinks the economy is well-positioned to handle, until “compelling evidence” of cooling inflation emerges. He noted that surging food and gas prices were not something the central bank could reign in, then said raising interest rates this summer could cause a recession.

“It’s not our intended outcome at all, but it’s certainly a possibility,” Mr. Powell said Wednesday during the first of two days of congressional hearings. “We are not trying to provoke and do not think we will need to provoke a recession, but we do think it’s absolutely essential” to bring down inflation, which is running at a 40-year high. Many expect widespread market volatility until it becomes clear the Fed is not going to force the economy into contraction, following the bank’s decision to raise interest rates by 75 basis points for the first time in nearly three decades.

On Monday, President Biden reiterated that a U.S. recession isn't "inevitable" following a conversation with former Treasury Secretary Larry Summers, but the high-profile economist continued warning about the risks of stagflation at a speech later in London. "We need five years of unemployment above 5% to contain inflation - in other words, we need two years of 7.5% unemployment, or five years of 6% unemployment, or one year of 10% unemployment," he declared. "There are numbers that are remarkably discouraging relative to the [Fed] view. Is our central bank prepared to do what is necessary to stabilize inflation if something like what I've estimated is necessary?”

Added Powell: "The events of the last few months around the world have made it more difficult for us to achieve what we want. We've never said it was going to be easy or straightforward." The messaging is different from his stance on March 2, when Powell said it is "more likely than not that we can achieve what we call a soft landing."

On a positive note, when asked about a new report that indicated retail sales slipped back last month, Powell said that over-all spending remained strong and there was no sign yet of a broader slowdown in the economy. The Fed’s newest projections show G.D.P. growth slowing sharply, from an annual rate of 5.7 per cent in 2021 to 1.7 per cent this year and the same next year. They also forecast the unemployment rate rising from its current rate of 3.6 per cent to 3.9 per cent in the final quarter of 2023, as inflation, measured by the Fed’s favorite index, falls back dramatically, to 2.6 per cent.

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