Until about, er, last Thursday, the talk in macroeconomic circles was no longer just whether the US economy was facing a hard or soft landing: “no landing” was the hot new prediction.
US economic data proved remarkably impervious to both the physical pain of aggressive rate hikes and the more psychological agony of bad vibes. The US labor market just DGAF, it seemed.
The collapse of Silicon Valley Bank and the broader financial ructions it has unleashed have now radically changed the narrative again. For example, Apollo’s Torsten Sløk says he has switched from Team No Landing to Team Hard Landing. His underline below.
When the facts change, my view changes. A financial crash has occurred and we are going from no landing to a hard landing driven by tighter credit conditions. Small banks account for 30% of all loans in the US economy, and regional and local banks will likely now spend several quarters repairing their balance sheets. This likely means much tighter lending standards for businesses and households, even if the Fed would begin cutting interest rates later this year. As the regional banks play a key role in US credit expansion, the Fed will not raise interest rates next week and we have likely seen the peak in both short and long interest rates this cycle.
Here’s a chart that underscores his point.
BlackRock’s Larry Fink raised a similar point in his annual letter to investors earlier this week.
While it was still unclear whether the SVB debacle would spill over into a big, fat new S&L crisis, “it seems inevitable that some banks will now have to pull back on lending to shore up their balance sheets, and we will likely to see stricter capital standards for banks”, he wrote.
Jan Hatzius’ team at Goldman Sachs has just published a report that digs a little more into the subject. Here is the dotted abstract. FTAV weight below:
– American policymakers have taken aggressive steps to strengthen the financial system, but concerns about stress in some banks persist. Continued pressure could prompt smaller banks to become more conservative in lending to preserve liquidity in case they have to meet depositor withdrawals, and a tightening of lending standards could weigh on overall demand.
— Small and medium-sized banks play an important role in the American economy. Banks with less than 250 billion USD in assets account for about 50% of US commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending and 45% of consumer lending.
— Any lending effect is likely to be concentrated in a subset of small and medium-sized banks. While the two banks taken into receivership account for only 1% of total bank lending, the lending shares are 20% for banks with a high loan-to-deposit ratio, 7% for banks with a low share of FDIC-insured deposits , and 4% for banks with a low retail share of deposits.
— The macroeconomic impact of a withdrawal in lending will remain highly uncertain until the extent of the stress on the banking system becomes clear. We assess it using two approaches. Our accounting approach assumes that small banks with a low share of FDIC-covered deposits reduce new lending by 40% and other small banks reduce new lending by 15%. This implies a 2.5% draw on the total stock of bank loans, which economic studies suggest will result in a draw of approx. ¼ percentage point on GDP growth in 2023. Our statistical approach extends our growth impulse model of financial conditions to include bank lending standards, which we assume will tighten significantly further, implying a ½ percentage point drag on GDP growth beyond what is already implied of the delayed effect of the tightening in recent quarters.
— We have lowered our forecast for GDP growth for 4/4. quarter 2023 by 0.3 percentage point to 1.2% to incorporate these estimates of tighter lending standards, reflecting in part a larger downward revision in investment spending.
— Unless banking stress changes the outlook significantly, the Fed’s goal for the year will be to keep demand growth below potential to keep the rebalancing of supply and demand on track. Tighter bank lending standards help curb demand growth and share the burden of monetary policy tightening. Our analysis suggests that the gradual tightening of lending standards that we expect from stress on small banks will have the same impact on growth as around 25-50bp of rate hikes would through their impact on market-based financial conditions.
Goldman Sachs has been one of the most optimistic banks on Wall Street, but even its confidence seems shaken. Separately. the bank’s economics team raised its odds of a US recession in the next 12 months from 25 percent to 35 percent.
It’s a fascinating situation. The “normal” trigger for banks to rein in lending is credit risk: A weaker economy causes more loans to go bad, and more bad loans prompt banks to cut back on lending, further weakening the economy.
But it is basically (so far at least) about interest rate and financing risk. So the dynamics can be very different.