What is the outlook for global credit conditions

Credit data suggests to us that recessions beckon in the US and Europe.

By way of tradition, we’ll share the good news first. The good news is that there has not been a substantial tightening of credit conditions by banks in spite of the recent turmoil in the banking sector, particularly in the US. The bad news is that credit demand by firms has fallen through the floor – and not just in the US.

Credit data suggests to us that recessions beckon in the US and Europe. What’s more, credit data is probably the best guide to recession risks; better than things like yield curve shape or business surveys. On occasion, notably during the 2008 global financial crisis, contracting credit can be caused by banks tightening their lending standards. Even sharp cuts in policy rates by central banks cannot quickly restore economic activity in this situation until banks recover. No doubt many might fear that recent tensions in banks, particularly in the US, could spark a recession as banks, and particularly small banks, clamp down on extending credit.

However, the most recent data from the Federal Reserve, in its senior loan officer survey, suggests that, while credit conditions can be considered relatively tight, there has been no sharp tightening of credit supply since the first bank failures in mid/late March. Perhaps unsurprisingly, credit conditions in the euro zone, while relatively tight in historical terms, have not tightened at all since a number of US banks fell over and UBS swallowed up CSFB in Switzerland.

This all seems like good news. But the problem seems to be that high interest rates appear to be doing the job of tighter credit, and more, in depressing loan demand. Credit conditions and loan demand in both the US and euro zone, reveals that the biggest movement has been the capitulation in loan demand, not the tightening of credit conditions.

In other words, it looks as if the US and the euro zone are walking towards a recession anyway on account of weak loan demand, and don’t really need the final push over the edge that could come from a material tightening of loan conditions. What’s more, it is not just central bank data that is saying this. If we look at small US firms, who we might expect to be particularly impacted by the struggles of regional banks in the US, we see that the last survey from the National Federation of Independent Business (NFIB) for April put the availability of loans on a par with what we were seeing back in January.

However, on the other side of the coin, small firms’ plans for capital spending over the next few months are weakening more materially. Of course, firms can fund from the cash they hold rather than new loans but we still think that the NFIB data are indicative of the fact that credit demand has fallen notably.

Many analysts said for the Fed, and the ECB, a slowdown in loan demand is exactly what the doctor ordered and the more this is driven by higher rates and not credit restrictions from banks the better. But the problem lies in calibrating this correctly. Yes, central banks want to slow loan growth as part of their effort to reduce inflation, but recent data seems consistent with the idea that this slowdown will turn recessionary and, as far as we can tell, central banks would like to avoid recessions if at all possible.

"Things could conceivably get even worse if it proves to be the case that banks have just been slow to tighten credit conditions and, as these tighten significantly in the future, could hit economies hard. Perhaps the saving grace here is that, with loan demand already weak, it might not make a huge deal of difference if credit availability deteriorates sharply. But, in keeping with the theme of following good news with bad news, such a turn of events might not be any more negative for the growth outlook solely because major economies in the US and Europe will already be in, or near to, a recession", said an analyst.