However, our models still point to elevated recession risk, and a recession beginning later this year remains our base case. Stresses in the banking sector mean that credit conditions are likely to continue to tighten, consistent with the Fed killing the cycle.

Given that we think a recession is necessary to restore price stability, recent economic strength increases the risk of a more persistent inflation overshoot. This would see the Fed tightening even further, as in our “Fed has two bites of the cherry” alternative scenario.

A systemic financial crisis on the scale of 2008 remains unlikely, but is another source of downside risk. Key indicators to monitor the risk of a credit crunch include unrealised losses in the banking sector; the flow of deposits to money market funds; bank earnings data; and use of the Fed’s liquidity provisions.

These indicators suggest that the banking sector as a whole remains under stress, with some institutions in particular looking especially vulnerable. While there will be negative economic spillovers, the Fed seems to have the tools to contain systemic risk.