After delivering a fresh interest-rate hike Wednesday, Federal Reserve Chair Jerome Powell signaled that Monday’s senior loan officer opinion survey, which typically polls more than 80 lenders, will show tightening lending standards. The extent of the decline will be closely watched.
Thank restrictive monetary policy and bank turmoil for creating headaches for borrowers across the globe, from mom-and-pops to blue-chip companies. Over in Europe, appetite for corporate loans plunged by the most on record in the second quarter – a faster slowdown than anticipated.
Add new US regulations that would force big banks to hike their capital buffers by billions of dollars and a case can be made that the long-anticipated stiffening of lending conditions is playing out.
But its economic impact is less clear. Noting easing demand for commercial and industrial loans, the likes of Citigroup reckon the shift in the credit cycle could cut inflation-adjusted gross domestic product in the US and Europe by around 1% to 2% by the end of next year.
“Its impact on the broader economy is taking longer as the overall liquidity in the system remains robust,” said Marvin Loh, global macro strategist at State Street Corp., referring to interest-rate hikes.
For now, fixed-income investors seem relaxed. The extra yield that investment-grade corporate debt pays pays over government bonds is nearing the lowest since just before the regional banking crisis left money managers looking for safe havens.The sanguine market tone reflects the fact that recession bets have misfired all year, while alternative financiers like private credit firms are stepping up.
“Continued tight monetary policy is certainly a drag on credit extension, but having the end in sight with increasing confidence can help ease that constraint,” said Steven Kelly, who researches financial crisis management at Yale University. “Skepticism of a so-called soft landing continues, but as the Fed continues to do the perceived-improbable on that front, the soft landing view will only grow in acceptance.”
New capital requirement rules, with the biggest lenders having to boost their capital requirements by 19%, are also a headache for Wall Street.
The proposal, which likely won’t be implemented for years, is probably already having an impact, according to Kelly. “At least at the margin, the expected path of bank capital regulations also is likely weighing on new bank credit extension,” he said before the official announcement earlier this week.
Any knock to the economy from credit tightening would be clearly painful for the slew of companies that have built up a mountain of debt in the easy-money years and are now facing soaring borrowing costs. Issuers have responded by making larger payments on their commercial loans, Bank of America chief financial officer Alastair Borthwick said on a call with analysts earlier this month.
In a note on Thursday, Armen Panossian and Danielle Poli at Oaktree Capital Management state their case for why elevated interest rates are set to send defaults higher.
“Asset bubbles created during the easy money era could deflate painfully, causing a rash of downgrades, distress, and, eventually, defaults,” they wrote.