Bank lending surveys are telling us something
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Article Type
BondTalk
Topic
Banks
Published
November 07, 2023
Read time
9 mins
Author
Alexander Pelteshki, CFA
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Bank lending surveys in the US and the EU show continued tightening of credit lending conditions and reduced loan demand from corporates and consumers. This indicates that the full impact of monetary tightening has yet to fully travel through the system, so we can expect reduced borrowing to continue into 2024, negatively impacting economic growth. We may well have seen peak interest rate increases in most major economies, which make government bonds look very interesting at current valuations.

 

Survey data reveals further tightening

 

In the US, the October 2023 Senior Loan Officer Opinion Survey (SLOOS) reported tighter standards and weaker demand for commercial and industrial loans, as well as for commercial real estate loans. For loans to households, banks also reported tighter standards across all categories of residential real estate (bar government residential mortgages), while demand for all residential real estate lending fell again across the board. Similarly, standards for all consumer lending categories (auto, credit card) tightened, while demand softened further.

 

Similarly, the European bank lending survey for Q3, released in October 2023, continued to paint a depressing picture. It showed further net tightening of credit conditions and weaker-than-expected demand for loans compared to what the banks themselves were expecting. Credit standards for SMEs and large enterprises saw additional net tightening in the quarter. This was evident across the board in the main Eurozone economies and was primarily driven by banks own risk tolerance and perceptions of the macro environment.

 

In domestic credit, European banks also reported further tightening of loans to households. Lending criteria for house purchases saw an additional net tightening in the quarter, particularly in France, while Italy has also begun to show worsening conditions.

 

On the demand side, the picture was equally subdued. The appetite of corporates for lending continued to decrease substantially in 3Q23. Moreover, that decline was materially higher than what the banks had expected, mainly driven by higher interest rates. Demand for housing loans declined further and by more-than-expected, as the prospects of the overall direction of the housing market as well as the high level of interest rates depressed overall demand for credit.

 

The last innings of the interest rate hiking cycle

 

Demand for credit has fallen off a cliff in Europe across both households and corporates, while bank lending standards continue to tighten. In the US lending conditions also continue to tighten, although at a slower pace.

 

We see this as a direct result of one of the fastest monetary tightening cycles in recent history. Moreover, we believe that not all the rate hikes have yet to find their way into the financial system, particularly in the US. The rapid pace of credit destruction is only partially being mitigated by a thus far benign refinancing wall, as well as an abundance of private credit to replace access to public markets. Both are likely to prove transient, and in our view are also insufficient to keep economies humming at or above trend growth.

 

The survey results suggest that we have seen the last innings of this very unusual and aggressive interest rate hiking cycle. As we move into 2024, credit conditions are likely to tighten further and economic growth should remain subdued. Inflation is now below base interest rates in the US and EU by some measure, which can give us confidence in our view that the current monetary policy is already in restrictive territory.

 

The opportunity in government bonds

 

Yields on government bonds are as high as they have been since just before the 2007 Global Financial Crisis. As we head into 2024 the combination of restrictive monetary policy, slowing economic growth and lofty valuations in government bond markets make current yields look attractive for investors.

 

Yield on 10-year government bond debt (%)

 

Yield on 10-year government bond debt (%)

 

Source: Aegon AM, Bloomber, From 1/11/2010 to 3/11/2023

 

It is hard to imagine that base rates will go up from here much more (or any further). There is little disagreement between market participants or indeed global central bankers (Powell, Lagarde) that current policy rates are in restrictive territory. This leads us to favour government bond markets at current levels.

 

The risk to this view is that supply dynamics and debt sustainability concerns may resurface again, similar to the episodes that we saw in the UK in Q3 of 2022, and in the US in Q3 of 2023. While growth worries are likely to trump supply dynamics in the medium term, we are cognisant of the technical headwind that supply expectations could present. If this were to be the case, the long end of government bond curves would be relatively more exposed, stemming from the already flat starting point, as well as the anchoring of the front end.

 

Government bond curve slopes (buy 5-year - sell 30-year, bps)

 

Government bond curve slopes (buy 5-year - sell 30-year, bps)

 

Source: Aegon AM, Bloomberg. From 7/11/2010 to 3/11/2023.

 

So, we like government bonds in general. Within that, we also view the front end of most developed rates markets as being particularly attractive, with curve-steepening trades a good way to express a positive interest rate duration view.

Important disclosures

Author

Alexander Pelteshki, CFA
Portfolio Manager

Alexander Pelteshki, portfolio manager, is a member of the investment grade and multi-sector portfolio management team. He specializes in top-down asset allocation, global strategic bond and global credit portfolios.

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