US week ahead: Lending vs. CPI, what will win out?
There are a lot of unanswered questions for investors at the start of a new week. Most of them revolve around what central banks will do next and when interest rates will be cut. The future of the global economy is also particularly murky: PMI surveys have turned sharply lower in China, which points to lower growth in future, and Europe also experienced some downward pressure on its survey readings for last month. However, the focus is on the US, as the Fed tries to do the impossible: tame inflation and manoeuvre a soft economic landing. So far, the soft economic landing seems to be doing ok, the only trouble is, this appears to be a zero-sum game: the Fed can either have a soft economic landing or weaker inflation, it cannot have both. The latest Senior Loan Officer bank lending survey from the Federal Reserve for Q1 has shown that lending standards have tightened during the first quarter and since the collapse of SVB bank, however, the data is not disastrous. We will have to see if this puts pressure on the Fed to keep interest rates sufficiently restrictive, especially if CPI comes in hotter than expected later this week.
Highlights from the Fed’s loan survey
All eyes were on Monday’s loan data from the Federal Reserve. The key highlights from the report include:
- Banks reported tighter standards and weaker demand for commercial business loans to large and medium enterprises.
- Tighter lending standards and weaker demand in the commercial real estate loan space.
- Lending standards tightened across all categories of residential real estate.
- Banks are also expected to tighten lending standards during the rest of the year.
- Banks cited deteriorating credit quality, a reduction in risk tolerance and concerns about access to funding as some of the reasons why lending standards were likely to be tightened later this year.
- Larger banks are also tightening access to consumer credit including credit cards and auto loans.
- While banks reported a falling share of people looking for auto loans, there was only a moderate decline in consumers looking for other types of loans, this was perhaps the only “bright” spot in this report.
- Mid-sized banks also report concerns about their own capital positions in the aftermath of the collapse of SVB and other regional lenders in recent months, a concern that was not shared by the larger banks.
Overall, this bank lending survey shows that lending standards are tightening and are expected to continue to tighten across commercial, residential and consumer lending sectors. Bigger banks are in a safer position than smaller lenders, who have additional worries such as the strength of their capital positions and deposit outflows, alongside concerns about future changes to banking regulation to contend with. Thus, banks have been impacted by the recent turmoil in the regional banking sector, this is impacting the banks willingness and ability to lend, which could impact economic growth down the line. The immediate market reaction to this survey is mixed: on the one hand weaker lending could tame inflation, on the other it could tank growth. Stocks generally have been unaffected, however the S&P 500’s regional banking sub index has picked up a little and is currently trading up 0.3%. the reason for the improved performance in this banking sub index could be because the Fed’s lending survey has not told us anything we did not already know or expect. Added to that, there is nothing to panic about in this survey, and no overt concerns about large scale bad loan write-downs or the commercial real estate sector.
Why the lending survey could have been worse
While lending standards are “tightening” the report did not prefix this with any concerning adjectives, for example, lending standards were not rapidly tightening or dangerously tight. Thus, while this report did not deliver good news, it did not deliver the doom and gloom that some may have expected. At this stage, this report is unlikely to move the dial for the Federal Reserve, we believe that we will have to wait until the CPI report before the market can re-price any interest rate risk if necessary.
CPI – will it move the dial for the Fed?
Overall, stocks were mixed at the start of a new week, with risk appetite generally directionless as the market awaits key US CPI data and a slew of corporate earnings later this week. After a stronger than expected reading for US payrolls, along with a boost to US average hourly earnings data for April, the focus now shifts to CPI data that is due later this week. If the US CPI rate doesn’t continue to fall, then it’s hard to justify a Federal Reserve pausing interest rate increases for long, unless they shift their mandate. Until we get confirmation of the CPI reading for the US, which is expected to show headline prices remaining steady at 5%, with annual core inflation falling back a notch to 5.5% from 5.6%, we expect markets to remain generally range bound with a risk off tone.
The future of EUR/USD and life below $1.10
After the Federal Reserve meeting last week, where the bank switched around some of their language, the market rushed to price in a slew of rate cuts in the next 9 months. According to the CME’s Fedwatch tool, the market is still pricing in 100 basis points of rate cuts between now and the end of January 2024. However, we have seen some analysts scale back their expectations for Fed rate cuts this year, with Goldman Sachs analysts now not expecting any rate cuts at all for 2023. While market-based interest rates have not yet reflected the shift in analyst expectations, we expect them to follow suit in the coming weeks. If the market does re-price interest rate expectations this is important for a few reasons: 1, it could be bad news for risk sentiment as expectations of cuts to interest rates tends to boost stocks, while expectations of higher interest rates tend to weigh on equity prices. 2, It could cause havoc in the FX space. The dollar has fallen out of favour as western central bank policy diverges with the Fed. If Fed rate cuts are scaled back, then it could give the dollar a boost. Already on Monday, FX traders seem to be ahead of the curve. EUR/USD is trading with a weak tone on the back of a resurgent dollar. This pair has been trading in a tight range in recent weeks between $1.1080 on the upside, and $1.0950 on the downside. The trigger for another leg lower in EURUSD, is likely to be fundamental: firstly, a stronger CPI reading in the US, which has the potential to lead a repricing of US interest rate risk, secondly, weaker PMI surveys from Europe are prompting some to expect a slowdown in the Eurozone later this year, which could force the ECB’s hand into pausing its interest rate hiking cycle sooner than it currently expects.
To conclude, all eyes are on Wednesday’s US CPI report, and whether EUR/USD loses its $1.10 handle.