The US banking crisis may spark a credit crunch and ignite a recession, elite strategist Liz Ann Sonders warns

• The US banking crisis could lead to a credit crunch and a recession, Liz Ann Sonders said.
• The veteran strategist warned fears of more bank runs could hit lending to consumers and businesses.
• The Fed may be too focused on inflation and not enough on financial stability, Sonders said.

The banking crisis could morph into a painful credit crunch that tips the US economy into recession, Liz Ann Sonders has warned.

Silicon Valley Bank's sudden collapse earlier this month sent shockwaves through financial markets, fanning fears of further bank runs toppling other lenders.

The industry turmoil is likely to spur many banks to conserve cash and lend more cautiously, making it tougher for consumers and businesses to borrow money, Sonders said in a commentary on Wednesday.

Charles Schwab's chief investment strategist noted that credit drying up would likely slow the economy, cooling inflation but increasing the risk of a recession. Given that prospect, she cautioned the Federal Reserve might be worrying too much about slowing the pace of price increases, and not enough about stabilizing the financial system.

The US central bank has hiked interest rates from nearly zero to upwards of 4.75% since last March, in an attempt to curb historic inflation. Higher rates encourage saving over spending and raise borrowing costs, which can put upward pressure on prices.

However, higher rates tend to reduce asset prices and soften demand, boosting the odds of a recession. They can also weigh on banks by tanking bond prices, leading to large, unrealized losses in the lenders' fixed-income portfolios.

The upshot is the Fed now has to weigh the risk that further hikes will cause more banks to fail and tank the economy, against the possibility that not hiking enough will allow inflation to become entrenched.

"The Fed has a fairly small opening in the needle it's trying to thread in balancing the threats associated with the banking crisis, and the need to combat still-high inflation," Sonders said.

The elite strategist also reiterated her view that the US economy is experiencing a "rolling recession," with some sectors such as housing under pressure while others are booming. She warned that if credit dries up, the patches of weakness could spread.

"Although Powell said there remains a 'pathway' to a soft landing, we believe what we've been calling a 'rolling recession' is more likely to roll into a more formal recession," she said.

Sonders added in a CNBC interview on Wednesday that the banking crisis was already causing wider problems.

"We're starting to see some cracks on the services side," she said, suggesting that regional banks might be lending less to smaller businesses.