Back Into Deflation

Here are some of the biggest stories from last week:

• US banks continued to tighten their lending standards last quarter.
• The IMF raised its forecasts for China’s economic growth this year and next.
• China’s imports unexpectedly rose last month, but exports continued to fall.
• The country also slid back into deflation in October.
• The UK economy stagnated last quarter.
• Central banks are snapping up gold at a record pace.

Dig deeper into these stories in this week’s review.

US bank lending

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 completed in October to assess the lending environment over the third quarter of 2023, and the results were published this week. The graph below, taken from those results, shows the proportion of banks reporting that they’ve tightened their lending standards to commercial and industrial customers. Note that the figures are calculated as net percentages – that is, the share of banks reporting tighter conditions minus the proportion of banks reporting easier standards. When the line goes up, as it’s been doing since the start of 2022, it means banks are becoming more cautious about dishing out business loans.

Now, the bad news is that according to the latest survey, US banks broadly reported tight lending standards and weak demand for loans in the third quarter. But the good news is that both measures improved somewhat compared with the prior three-month period. More specifically, the net proportion of banks tightening standards on commercial and industrial loans for medium and large businesses fell to 33.9%, from 50.8% in the second quarter. In terms of why banks are still not easily dishing out loans, they most frequently cited a less favorable or more uncertain economic outlook, reduced tolerance for risk, a deterioration in the credit quality of loans and collateral values, and concerns about funding costs as important reasons.

Despite the quarter-over-quarter improvement, several economists were quick to point out that the numbers are still pretty dire and do little to dispel fears about a looming credit crunch – especially after the turmoil in the banking sector earlier this year. 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. The blue line plots the results of the SLOOS survey – specifically, the net 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).

China

The IMF raised its forecasts for China’s economic growth this year and next on the back of stronger policy support from the government, but cautioned that weakness in the property sector and muted external demand would persist. The fund now sees China’s economy expanding by 5.4% this year, up from a previous estimate of 5%. It also upgraded its growth forecast for next year to 4.6% from an earlier projection of 4.2%. Over the medium term, GDP growth is projected to decline gradually to about 3.5% by 2028 due to weak productivity and an aging population.

The IMF’s upgrade this week coincided with Chinese trade and inflation data for October. The former painted a mixed picture of the economy, as an unexpected pickup in imports was offset by signs that global demand for Chinese goods is struggling to gain traction. Imports rose 3% in October from a year ago, marking the first gain in eight months and defying forecasts for a drop. Exports, on the other hand, fell by 6.4% – the sixth consecutive month of declines and significantly surpassing analyst projections for a 3% drop. That came as a big disappointment considering that the period was expected to be more advantageous compared to October last year, which faced pandemic-related disruptions in logistics and production.

The latest inflation report, meanwhile, showed China slid back into deflation in October, highlighting the country’s struggle to shore up growth by boosting domestic demand. After remaining virtually flat in August and September, consumer prices fell by a more-than-expected 0.2% last month from a year ago, undermining a recent assessment by the Chinese central bank that prices would rebound from the summer’s rough patch. Producer prices, meanwhile, fell for a 13th straight month, dropping 2.6%. While the latest inflation data is making investors more cautious about China’s growth recovery, it’s also fueling hopes for additional policy support, such as more interest rate cuts or a further reduction to banks’ reserve requirement ratio.

UK

The British economy flatlined in the third quarter, registering no growth from the prior three-month period as strong trade activity offset contractions in consumer spending, business investment, and government expenditures. While this outcome was marginally better than the 0.1% drop forecast by economists and reduced the likelihood of a recession in 2023, it also points to an extended period of economic stagnation, exacerbated by higher interest rates. The Bank of England, for example, predicted earlier this month that the UK economy will register a measly 0.1% gain in the fourth quarter and no growth through 2024.

Gold

Central banks globally have bought a record 800 tonnes of gold in the first nine months of 2023, up 14% from the same period last year. This surge in purchases is part of efforts by countries to hedge against inflation and diversify their reserves to reduce their reliance on the dollar – especially after the US weaponized the greenback in its sanctions against Russia. Leading the pack is China’s central bank, which has snapped up 181 tonnes of gold this year, taking its holdings of the metal to 4% of its reserves. That’s also encouraged the country’s consumers to buy gold as a store of wealth in the face of a property crisis, a falling yuan, and tumbling yields.

The unrelenting pace of buying by central banks has helped the price of gold defy a strengthening dollar and surging bond yields, both of which would normally lead to lower gold prices. See, like most internationally traded commodities, gold is priced in dollars. If the dollar strengthens compared to other currencies, gold becomes more expensive for most of the world to buy – decreasing international demand and pushing down the metal’s price. Rising bond yields, meanwhile, increase the “opportunity cost” of owning gold (instead of bonds) since the metal doesn’t generate income. In other words, gold looks less attractive when bonds offer better returns, and that causes its price to fall.

All in all, central banks' purchases of gold this year could exceed last year’s record of 1,081 tonnes. That, combined with strong demand from Chinese investors, has helped keep the price of the shiny metal not far from its all-time high of $2,072 a troy ounce.

Next week

• Monday: Nothing major.
• Tuesday: UK labor market report (October), US inflation (October). Earnings: Home Depot.
• Wednesday: Japan GDP (Q3), China retail sales (October), UK inflation (October), US retail sales (October). Earnings: Cisco.
• Thursday: Japan trade balance (October), US industrial production (October). Earnings: Walmart, Alibaba.
• Friday: UK retail sales (October), US housing starts (October).