The US may not be able to dodge recession as bank failures could lead to a credit crunch for small business, chief economist says

• The US is at greater risk of a recession because of a looming credit crunch for small business, Pantheon Macro's chief economist said. 
• Access to credit was getting tight before this month's bank failures, and now a "further ratcheting" is in store.
• He had thought the US economy could dodge a recession but that may be unlikely now, he said. 

The US economy appears firmly on the road to recession as small businesses will face higher hurdles to obtain credit in the wake of the first bank failures since 2008, the chief economist at Pantheon Macroeconomics said  Monday.

Banks were already tightening access to credit after the Federal Reserve began raising interest rates last year to cool down the hottest inflationary environment in 40 years. 

Then came this month's collapse of Silicon Valley Bank, Signature Bank and Silvergate Bank. Regulators shuttered SVB and Signature to prevent a further run on deposits. 

Investors worried about the safety of their uninsured deposits have pushed $286 billion into money market funds since the bank failures.     

"[You] have deposits running away from banks and going at the money funds and you have bank management thinking, "Okay, how do we survive this now? Well, we probably don't do it by by lending," Ian Shepherdson,  chief economist at Pantheon Macroeconomics, said in an CNBC interview on Monday. 

"So my guess is what we're going to see over the next few months is a further ratcheting up of lending standards," he said.

"In a modern banking-driven developed economy, when the flow of credit is squeezed, bad things happen to growth. So, I'm getting really nervous now that an economy that I thought was going to dodge recession - just -  is now at much greater risk of falling into one,"  said Shepherdson, who called the 2008 housing bubble.

A recession "could be quite severe" and Federal Reserve officials are still gauging the scope of likely contraction in the world's largest economy, he said. 

"[Bank] credit is the lifeblood for small businesses and most people work for small businesses. They drive a huge amount of economic activity, and they're really going to struggle," he said. 

Companies with fewer than 500 staff members make up 58% of the privately employed workforce in the US, Shepherdson wrote in a Pantheon Macro note published late last week, illustrating the importance of small businesses to economic activity. 

Strength in the labor market has fed the view that the US economy could stave off a recession or prevent a deeper downturn in economic activity. As of February, the job market had posted roughly two years of growth. Part of that time, the Fed's rate hikes have been working their way through the economy. The Fed has raised interest rates from zero to a range of 4.75%-5% since March 2022. 

"It's not like this comes out of a clear blue sky," Shepherdson said of a looming credit crunch.

"I've been watching these loan officer surveys from the Fed itself getting tighter and tighter and already getting up to levels that normally are consistent with a pretty unpleasant situation for business borrowers and then we get the bank failures on top," he said.