In the U.S., a surge in deposits from small to medium-sized lenders is leading to a credit crunch across the country as smaller financial institutions sell mortgages and bonds at record pace to offset losses. This looming crisis is causing concern within financial markets about how it will affect economic growth moving forward.
The US earnings season has been relatively strong, with 76 per cent of the 87 companies in the S&P500 index that have reported their quarterly results presenting better than expected numbers. In particular, major banks such as JPMorgan Chase, Wells Fargo and Citigroup are standing out thanks to higher interest rates and a large influx of customers seeking security after Silicon Valley Bank’s collapse.
Analysts warn that if lending continues to be cut back significantly there could be dire consequences for businesses who rely on access to capital - particularly those already struggling due to the pandemic - potentially stalling any recovery efforts currently underway in America’s economy.
Deposit outflows
A credit crunch is looming. Small banks are selling mortgages and bonds at a record pace to offset deposit outflows. The result: a strong contraction in lending. “Banks saw the strongest two-week decline ever in their lending,” said Mike Wilson, chief investment officer at Morgan Stanley, in his podcast Thoughts on the Market in response to the latest quarterly figures.
Lending from small and medium-sized banks is the lubricant of the US economy. According to a report by Goldman Sachs, lenders with less than $250 billion on their balance sheets account for about 50 per cent of consumer and business loans in the US, 60 per cent of residential mortgages, 80 per cent of commercial real estate loans and 45 per cent of consumer loans.
Credit Conditions US
Shifting money to larger banks has already led to a «significant» tightening of credit policy in the US, and is creating further pressure on the real economy, acknowledges Goldman Sachs› head of multi asset sustainable solutions Ewout van Schaick. An analysis of Fed data and Refinitiv data by JPMorgan’s economic agency (chart) confirms that assumption.
“US credit contraction has probably already begun,” tweeted analysts at asset manager Gavekal. “As companies lose access to credit, more unprofitable companies are likely to be forced into bankruptcy,” they write. This would lead to massive layoffs and higher unemployment rates, increasing the risk of a recession. “Investors should take a risk-averse approach to asset allocation in the US,” Gavekal said.
Van Schaick is also cautious about equities. “The upside potential for equities is limited at the moment. As the broad equity market was only moderately affected by the banking stress in March, valuations remain at high levels. ‹Growth stocks are even priced at a premium to the broad market.” In addition, central banks are unlikely to cut interest rates any time soon due to persistently stubborn inflation, Van Schaick said.
Textbook
The fact that credit is now being rejected, thereby curbing consumption and investment demand, is exactly what monetary policy aims to do, said Mark Sanders, professor of macroeconomics at Maastricht University. “If that leads to a recession, that policy will be readjusted,” Sanders said. “This seems to me to be the normal monetary transmission. ‹We may not be used to that after a decade of quantitative easing and low interest rates, but it’s actually straight out of the textbook.”
A widely used indicator of a possible credit crunch, the ICE BofA US High Yield Index Option-Adjusted Spread, shows no sign of turmoil in the market. The index shows the risk premium investors demand for holding high-yield bonds, relative to «risk-free» bonds. A low spread indicates that the market is willing to be compensated less for the extra risk associated with owning risky bonds.
It is unclear whether the credit market is dealing with irrational calm or a justified confidence - or creditum in Latin - of investors in the financial stability of companies and their ability to repay their debts, a prerequisite for unfettered lending.
This article originally was published on InvestmentOfficer.nl.