“Peak pain” for the US economy from the most aggressive rate-hiking cycle in a generation is likely “still a few quarters down the road.”

That’s according to a recent note from Jefferies, whose Thomas Simons offered what I’ll call a differentiated take on the macro outlook compared to the somewhat homogeneous assessments emanating from economics teams at America’s largest banks.

Simons warned on “false dawns” and “deeper drags” as the impact of policy tightening manifests on a lag. He pointed to the divergence between the goods-producing sector — which is showing signs of strain, as evidenced by a lackluster March ISM manufacturing report, among other data — and the services side, which is obviously still performing well.

Consumption is the economy’s load-bearing pillar, but even it could crack if it’s forced to hold up the entire structure, as opposed to “just” three-quarters of it. “The resilient sectors of the economy, including the consumer, can only be resilient for so long, and they are bearing more weight in carrying the economy than they can stand,” Simons suggested.

Importantly, Jefferies’s below-consensus outlook doesn’t rely on any assumptions about banking sector stress, although last month’s unfortunate events plainly help make the case if you’re in the camp expecting a deeper or longer downturn. “The factors that we expect to push the economy into a recession in Q3 were in place long before the failure of Silicon Valley Bank and Signature Bank,” Simons remarked.

In addition to the policy lags, Jefferies worries about “exhausted household balance sheets” and the potential for small businesses to see their access to credit severely constrained.

Some economists and analysts have argued that policy now acts more quickly (or “efficiently,” if you like) to cool the economy, but if you ask Jefferies, lags this cycle might actually be longer. That’s in part due to what, so far anyway, looks like a resilient consumption impulse despite a meaningful drop in total wealth.

Although the savings rate recently hit record lows, it’s up two percentage points since the nadir in June. Competition for deposits is likely to heat up going forward, and that could easily lift rates on CDs and savings accounts. That, in turn, “suggests the savings rate will continue to recover and generate a drag on growth,” according to Simons.

Importantly (and this is actually what I wanted to highlight), Jefferies suggested the rate on loans to small businesses had further to climb even before recent bank stress. Rates on small business loans are up 300bps since early last year, and just based on the median Fed dot for 2023 (i.e., 5.1%), there’s another 150bps to go, according to Simons, who said small business rates may approach 10% by mid-year.

“These models to do not include any adjustment for small- and mid-size banks facing higher funding costs as a result of the recent deposit flight,” he went on, calling 9.5% a “baseline, optimistic scenario” for small business bank loan rates, before noting that it isn’t terribly difficult to image rates going higher but “it is hard to see why they would end up lower than our estimate.”

Recall that Goldman recently warned about the potential read-through of March’s bank stress for small, services sector businesses which, lacking access to capital markets, rely heavily on loans. Tighter lending standards at regional banks could have a disproportionate impact on hiring in the services sector through that channel, analysts led by Jan Hatzius said.

Contrary to notions (popular late last year) that the worst of the drag from the rate hikes might be behind the US, Jefferies characterized last month’s tumult as “a stark reminder that the economy is still very sensitive to short-term interest rates,” which the Fed may not be done raising quite yet.

Simons went on to warn that higher borrowing costs “will coincide with a sharp slowdown in nominal revenue growth” as inflation slows and pricing power wanes, set against persistently elevated labor costs, a recipe for margin compression.

The bottom line, for Jefferies, is that, “Peak pain is still yet to come, and it may be worse than we originally thought.”