Credit stress is showing signs of abating in some areas of the market while increasingly deteriorating in others. It’s still a mixed bag as far as I’m concerned, with the most important segments of lending rapidly faltering. More than any other variable, bank lending signals whether liquidity is flowing to companies and individuals; if it isn’t, that’s a highly deflationary signal constricting economic growth.
High yield bond spreads, mortgage-backed debt and investment grade bonds have all seen their respective interest rate spreads decline versus Treasury bonds since mid-March. That’s a bullish sign for the markets. Also, the Dow Jones Transportation Average is just a few percentage points from an all-time high, stock market volatility has plunged and mutual fund investors are dumping money market funds and buying equity funds again.
Apart from the above, however, the bigger picture doesn’t look too pretty.
For consumers and businesses, bank credit continues to worsen in the United States. What’s alarming is the growing infection of tightening bank credit now encompassing the entire lending spectrum, as banks hoard their available cash reserves for the highest quality borrowers.
The Federal Reserve’s survey of banks’ senior loan officers found that the credit crunch is widening and now affecting a greater share of the economy. The proportion of domestic banks tightening their lending standards was at, or near, historical highs for virtually all loan categories, including credit cards and student loans.
In April, 44% of banks surveyed tightened their lending standards to consumers, up from 30% in January. For residential real estate loans, 70% of banks tightened standards compared to the prior three months – at exactly the wrong time. The mortgage market needs liquidity in order to create loan expansion in a distressed environment. More alarming, 60% of banks tightened their books on prime mortgages, up from just 15% 12 months earlier. And commercial real estate loans continue to feel the squeeze as 80% of banks tightened lending.
Some parts of the credit spectrum are improving and that’s good news. Unfortunately, the improvements lie mainly in the capital markets, which don’t affect the majority of real economy participants. The Fed’s April loan survey is a bleak picture. The real economy is deteriorating, not improving. This data confirms that consumers and businesses are struggling as credit becomes harder to secure – and that’s ultimately bearish for the market.
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