SLOOS: Crunch Time Looms

Last week was certainly a heavy one from a macro perspective. On Monday, the results of a closely watched Fed survey showed banks tightening their lending purse strings, which did little to dispel fears of a looming credit crunch. But the report did strengthen the case that the Fed may finally be done with its rate-hiking cycle – an argument that got a further boost after data out last week showed US inflation moderating in April. However, while investors continue to expect the Fed to cut rates this year, it might not be likely anytime soon with inflation still running hot and little progress being made in bringing down the core rate. Across the pond, the Bank of England left little room for debate, going ahead with its 12th consecutive rate hike last week and signaling more to potentially come. Find out more in this week’s review.

Credit crunch

The senior loan officer opinion survey (or “SLOOS”) is a quarterly review conducted by the Fed to gather information on bank lending practices. The latest one was conducted in April to assess the lending environment over the first quarter of 2023, and the results were published last week. The graph below, taken from those results, shows the percentage of banks reporting that they’ve tightened their lending standards to commercial and industrial customers. Basically, when the line goes up, as it has been doing since the start of 2022, it means that banks are becoming more cautious in handing out business loans. And the latest survey showed a higher percentage of banks making it tougher to get loans last quarter, not only to business customers, but also to households across all loan categories (mortgages, auto loans, credit cards, etc).

The survey also asked some special questions about banks' expectations for the remainder of 2023, assuming that economic activity evolves in line with consensus forecasts. The responses were far from reassuring: banks widely reported that they expect to tighten their lending standards over the rest of the year to both households and businesses, and across all loan categories. Needless to say, that’s not good news, and will only fuel fears about a looming credit crunch – especially after the recent turmoil in the banking sector. Credit, after all, is the lifeblood of the economy: when it gets harder to borrow cash, consumers spend less and businesses don’t invest as much, derailing economic growth and increasing the odds of a recession.

To see this more clearly, consider the graph below from Goldman Sachs. The blue line plots the results of the SLOOS survey – specifically, the percentage of polled banks reporting that they’ve tightened their lending standards to commercial and industrial customers (the same data as the graph above). Once again, when the line goes up, it means that banks are becoming more cautious. And when that happens, bank lending over the next few quarters ends up declining (a logical outcome). This is captured by the red line, which shows actual bank lending four quarters in the future. This is plotted on an inverted axis – that is, when the red line goes up, it means that bank lending fell in the future. Finally, the gray shaded areas indicate recessions.

Here’s the key conclusion: when the SLOOS survey indicates that banks are becoming more cautious in their lending practices, it often precedes a decrease in actual lending in the future – a harbinger of a recession (notice how the red line shoots higher during all the shaded gray areas). The Fed made a nod to these dynamics in its financial stability report out last Monday, warning that banks’ concerns about slower growth could lead them to make fewer loans, accelerating an economic downturn. That all adds to the argument that the Fed may be finally done with its rate hiking cycle. After all, many economists view the ongoing bank crisis and resulting credit crunch as having a similar effect to that of a few interest rate hikes.

Inflation

In case the Fed needed any more data points to consider a pause, the latest US CPI report out last week showed inflation moderating in April. Consumer prices in the US increased by 4.9% last month from a year earlier – the first sub-5% reading in two years and below the 5% both expected by economists and recorded in March. Core inflation, which strips out volatile energy and food components, also cooled last month by 0.1 percentage points to 5.5%, which was in line with economists’ estimates. And “supercore” inflation – the Fed’s favorite measure as it tracks core services but excludes shelter prices, and therefore is a better representation of labor tightness – also slowed to 5.1% from 5.8%. However, on a month-on-month basis, prices are still rising, with both headline and core consumer prices increasing by 0.4% in April from the month before.

Investors continue to anticipate rate cuts by the Fed later this year, and they added to those bets after last week’s CPI report. That comes on the back of concerns over a credit crunch following a series of bank collapses, fueling expectations of a significant economic slowdown that prompts the US central bank to intervene. However, despite signs of moderated price pressures in April, the Fed will need to see more than one month of data to be confident that inflation is on a sustained downward path. What’s more, the annual core inflation rate has remained almost unchanged since the end of last year, demonstrating the sticky nature of underlying inflation. So while the Fed might pause its aggressive monetary tightening campaign next month, it’s very unlikely to cut rates anytime soon with inflation still running hot and little progress made in bringing down the core rate.

Bank of England

While the Fed cut or not-to-cut debate rages on, another major central bank just went ahead with its 12th consecutive rate hike last week. The Bank of England (BoE) raised its benchmark lending rate by a quarter of a percentage point to 4.5% on Thursday – its highest level since 2008. And unlike the Fed, the BoE is far from signaling a pause, saying that further hikes may be needed if price pressures persist. That comes after the central bank revised its inflation forecasts significantly upward, acknowledging that it had previously underestimated the strength and duration of food price increases. Rather than expecting inflation to drop below its 2% target within a year as previously projected, the BoE now anticipates it will reach the target only in early 2025. For reference, inflation is currently running at 10.1% – five times the central bank’s 2% target.

There was some good news, however, with the BoE significantly raising its growth predictions by more than it's ever done since it became independent in 1997. The central bank no longer expects a recession and now thinks that the economy will be 2.25% larger by mid-2026 than its earlier prediction in February. But the road to get there is bumpy, to say the least, with the economy expected to stagnate in the first and second quarters of 2023 when factoring in the impact of strikes and the extra bank holiday for King Charles III’s coronation. Excluding those one-off factors, the UK economy is expected to grow by 0.2% in each of the first two quarters of this year. But despite the upgraded projections, BoE officials stressed that the growth forecast was still weak with annual growth rates struggling to exceed 1% over the next three years.

This week

• Monday: Eurozone industrial production (March).
• Tuesday: China retail sales and industrial output (April), UK labor market report (April), eurozone GDP (Q1), US retail sales (April). Earnings: Baidu, Home Depot.
• Wednesday: Japan GDP (Q1), US housing starts (April). Earnings: Cisco.
• Thursday: US existing home sales (April), Japan trade balance (April). Earnings: Alibaba, Walmart, Applied Materials. 
• Friday: Japan inflation (April). Earnings: Deere & Co.