Despite Fed Tightening and Bank Collapses, La La Land’s Fiscal Position Still Surprisingly Loose

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Is it hard to squeeze all this liquidity out of the financial system after years of money printing and pandemic stimulation?

By Wolf Richter of Wolf Street.

Financial conditions and lending standards are much less relaxed than they were in the free-money era, when deposit rates were 0% and banks borrowed money from depositors for free. And the temporary surge of “financial stress” during the SVB collapse has subsided again, returning to a gradual state, but only a little less gradual than in the free-money era. The party seems to be over, but for now I’m just relaxing in La La Land and not suffering from a hangover.

The weekly St. Louis Fed Financial Stress Index is one of the products born out of the financial crisis, designed to measure financial stress in the credit markets and indicate when another financial crisis is approaching. It dutifully surged when SVB collapsed in mid-March, but only briefly and not by much, before settling back into La La Land.

A level of zero indicates normal market conditions. Levels above zero indicate market stress above average. Less than zero indicates below average market stress. Thursday’s latest release is below zero: -0.35. During the SVB collapse, it surged to +1.54 on March 17th, returned to +0.34 on March 24th, and remained above zero for two weeks. It then returned to a negative La La Land reading (green line = current level).

Last year’s big rate hikes led to a series of minor financial stresses that were above normal but still reached low levels. This year is different. Rate hikes did not add to fiscal stress. This year, the sudden bankruptcy of SVB added to the financial stress.

But the collapse of the First Republic only made the financial markets yawn. Same old time?

The St. Louis Financial Stress Index measures various Treasury yields, corporate bond yields, Treasury spreads, corporate bond spreads, SOFR spreads (which replace LIBOR spreads), and other spreads, as well as VIX and Treasury 10-year breakeven inflation rates. .

The index soared to +9.25 during the financial crisis right after the Lehman shock, so that’s about it. 6 times SVB decay value (+1.54).

In 2011-2012, the euro debt crisis also appeared in the US credit market.

And we see the US oil crisis that began in 2015 sent dozens of US oil and gas companies into bankruptcy court. The Fed kicked off its rate hike cycle in December 2015, but the core PCE price index was 1.1%, well below the Fed’s target of 2%. Frightened by oil and gas credit turmoil and inflation falling short of target, the Fed suspended its activity for a year and then continued. (green line = current level).

Financial situation is somewhat loose.

The broader Chicago Fed’s National Financial Conditions Index (NFCI) shows a similar picture, with “financial conditions easing again” in the latest reporting week, when the index fell to -0.28 and three sub-indicators (risk (red)) states that all have declined. , Credit (blue), and Leverage (green) – contribute to negative readings.

This index is also constructed to have a mean of zero, based on data going back to the 1970s. The free money party was certainly a lot of fun, but it’s over now and I can see that the financial situation is now just relaxing in La La Land instead of partying.

You can see the SVB collapsing in a small dent on the right side. However, the financial situation remained less tight than average. And the fall of the First Republic wasn’t even recorded (chart via Chicago Fed).

So despite the Fed rate hikes and the QT, financial conditions are still looser than their long-term averages, albeit somewhat looser than in the free-money era.

The long-term view really shows what happens when financial conditions get tight. We’ve seen the financial crisis, the 2011/2012 euro debt crisis, the oil crisis, and the surge in March 2020.

Rising interest rates reduced demand for bank loans. Financing standards will become stricter.

The quarterly Senior Loan Officers Opinion Survey (SLOOS) on bank lending practices for April 2023 was also released last week.

Demand for loans from businesses and consumers is declining, but this is not surprising as interest rates are rising and borrowing is becoming more expensive and no longer free. Corporate demand for commercial and CRE loans declined. As for consumers, demand for mortgages has fallen as home sales have plummeted. And demand for auto loans fell.

But wait…these are the banks reporting the demand for auto loans. Automakers’ captive finance companies, the largest auto financiers, offer subsidized low interest rates to stimulate sales volumes of certain models.

For example, Ford Credit is offering a 60-month 3.9% annual interest rate on a 2023 Ford 150 XLT pickup. But Bank of America currently advertises a 60-month new car rate of 5.99% per annum.

In other words, these loan officers may simply be reporting that the auto financing business is shifting further from banks to individuals.

Online, more lenders reported tightening lending standards across the board, with the exception of most government-backed consumer mortgages. For them, the lending criteria have not changed.

Loan officers began tightening lending standards in July 2022, but have tightened them even further after five straight quarters of easing lending standards during the free-money era. Tightened from a very loose goose-like base.

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