Moody’s sees risk that U.S. banking ‘turmoil’ can’t be contained

Still, the agency’s baseline view is that U.S. officials will “broadly succeed”.

Despite quick action by regulators and policy makers, there’s a rising risk that banking-system stress will spill over into other sectors and the U.S. economy, “unleashing greater financial and economic damage than we anticipated,” said Moody’s Investors Service, one of the Big Three credit-ratings firms.

Simply put, the risk is that officials “will be unable to curtail the current turmoil without longer-lasting and potentially severe repercussions within and beyond the banking sector,” Atsi Sheth, Moody’s managing director of credit strategy, and others wrote in a note distributed on Thursday. Still, the agency’s baseline view is that U.S. officials will “broadly succeed.”

Moody’s warning came as Treasury Secretary Janet Yellen indicated that the U.S. could take additional actions if needed to stabilize the banking system, and after Federal Reserve Chairman Jerome Powell assured Americans on Wednesday that the central bank would use its tools to protect depositors.

Beneath the surface, though, is lingering worry. Hedge-fund manager Bill Ackman, for example, is warning of an acceleration of deposit outflows from banks and the latest global fund manager survey from Bank of America BAC, +0.63% found that 31% of 212 managers polled regard a systemic credit crunch as the biggest threat to markets.

Of the three ways in which banking-system troubles could spill over more broadly, one of them is potentially the “most potent,” according to Moody’s: That is a general aversion to risk by financial-market players and a decision by banks to retrench from providing credit. Such a scenario could lead to the “crystallization of risk in multiple pockets simultaneously,” the ratings agency said.

“Over the course of 2023, as financial conditions remain tight and growth slows, a range of sectors and entities with existing credit challenges will face risks to their credit profiles,” the Moody’s team wrote. Banks are not the only type of players with exposure to interest-rate shocks, and “market scrutiny will focus on those entities that are exposed to similar risks as the troubled banks.”

A second potential channel for spillover is through the direct and indirect exposure to troubled banks that private and public entities have — via deposits, loans, transactional facilities, essential services, or holdings in those banks’ bonds and stocks. And a third way in which banking problems could spread more broadly is through a misstep by policy makers, who have been focused on inflation and may not be able to respond effectively enough to evolving developments, Moody’s said.

On Thursday, U.S. stocks DJIA, +0.41%SPX, +0.56%COMP, +0.31% finished higher as investors continued to weigh the risks to the banking sector. The policy-sensitive 2-year Treasury yield TMUBMUSD02Y, 3.779% fell to its lowest level this year, while gold futures settled at a more than one-year high.

Last week, Fitch Ratings said that nonbank financial institutions, insurers, and funds were experiencing a variety of “knock-on effects” as the result of the sudden deterioration of a few U.S. banks.