Fed survey points to a slowdown of the US economy

Yesterday, the Federal Reserve published its quarterly senior loan officer opinion survey (SLOOS), which offers an insight into how lending conditions have evolved over the previous quarter among US banks. And, in a quarter that experienced continued headwinds from higher rates, market participants were eager to hear how the banks navigated the period and whether the supply and demand for credit was hit.

The overall report depicted an environment of tighter lending conditions, with banks responding that conditions were tighter than in the previous quarter. We note, however, that in some sectors the pace of tightening eased somewhat.

For commercial and industrial loans, 21 banks out of the 59 surveyed reported tighter lending standards to large and middle market firms, down from just over 50% last quarter. Demand for such loans was subdued over the period, surveyed with 30.5% of the banks reporting weaker demand, again an improvement from the lows of 55.6% and 51.6% in Q1 and Q2, respectively. 

Banks have advanced a range of reasons causing weaker lending standards – a more uncertain economic outlook, a reduced tolerance for risk and a deterioration in the credit quality of loans and collateral values, as well as concerns about funding costs. All of which stem from a weakening economy against a backdrop of higher rates.

The report also covers lending of various types of commercial real estate (CRE) loans. As expected, most respondents reported lending standards have tightened. For instance, out of the 58 banks surveyed in the multifamily residential properties sector, 38 had tightened lending standards. Across different subcategories within CRE lending, banks indicated demand weakening materially and typically 60% of the respondents reported weaker demand for CRE loans. 

Turning to consumer and residential mortgage lending, standards have tightened marginally among respondents, with about 15%-20% of the banks indicating tighter standards across various mortgage types. Demand was, however, materially weaker with roughly 60% of banks reporting weaker demand for the period. Credit card lending followed a similar trend with banks reporting tighter underwriting standards (28.9% of respondents), but demand remained relatively strong compared to other categories, with a net 9.1% of banks indicating weaker demand. 

The tightening reported in the October SLOOS report did not come as a surprise, with the uncertain economic outlook and the looming risk of a recession being the main culprits as to why. It is, however, interesting to go through the details of the report to assess consumers’ and banks’ behaviour. 

Companies appear more cautious as the overall need for borrowing has weakened over the quarter. Individuals have been more affected by higher rates and tighter lending standards as exhibited by a drop in demand for mortgage loans, but credit cards were an outlier, with only a modest drop in demand. 

The overall report describes a US economy that is slowing down over the quarter and is consistent with our view that the economy in the US is likely to experience a softish landing. In this context, owning a combination of US Treasuries as well as credit, which trades at attractive levels while avoiding the lower rated parts of the market, seems to be the right blend to take advantage of the very attractive yields on offer.