Up to 40% of the US economy is set to be squeezed by tighter financial conditions as credit crunch worsens, strategist says

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• Credit conditions are set to worsen, according to veteran market strategist David Roche.
• That's because banks will keep tightening lending standards in the wake of the SVB crash.

The credit crunch in the wake of March's bank failures is likely to worsen, and up to 40% of the US economy could be squeezed as financial conditions keep tightening, according to veteran market strategist David Roche.

In an interview with CNBC on Thursday, the Independent Strategy president pointed to tightening credit conditions stemming from the failure of Silicon Valley Bank last month.

And that crunch is only set to intensify, Roche said, as central bankers now face a difficult balancing act of loosening monetary policy to prevent more banking tremors, while still trying to keep policy tight enough to control inflation.

"In a sense, you've got a schizophrenic personality of every central bank, which is doing with the right hand one thing and with the left hand the other thing," he said. "I think we will see the credit tightening because actually, the overall transmission to commercial banks is one of fear."

It spells trouble for a good chunk of the US economy, particularly for "small-town" sectors, like services, hospitality, construction, as well as small- to medium-sized businesses. That's because smaller regional banks finance over half of all lending in these spaces, Roche said, though those areas make up around 35%-40% of total output in the economy.

His warning comes just a little over a month after the collapse of SVB, which roiled the banking sector in March and led to heightened deposit flight, particularly regional banks. That's made banks less willing to lend, according to data from Morgan Stanley. In the past two weeks, banks have tightened credit the most they ever have in the past two weeks.

Though he said he doesn't believe the economy is currently in a recession, Roche warned that the credit crunch could weigh on economic growth, and was bearish for stocks.

"I would be underweight or short equities, because I think we've had one of these kind of rallies that succeed each other like waves at the top of the sea, where the crest of the wave will probably go down from here," he said, adding that the Fed was unlikely to cut interest rates soon.

The Fed has tightened monetary policy and hiked interest rates aggressively in the past year to control inflation. Officials have said rates will continue to remain restrictive in 2023 despite the recent banking turmoil, with markets now pricing in another 25 basis-point hike from central bankers in May.