Investors are growing increasingly concerned about
the possibility of a credit crunch hitting the US
economy, which could potentially trigger a recession.
This comes after the collapse of Silicon Valley Bank
and Signature Bank in March, causing prominent
economists like Nouriel Roubini, Bill Gross, and
Jeffrey Gundlach to warn of an impending credit
crunch.
Americans are already feeling the impact, with a
rising number of households reporting a
deterioration in their access to credit. The New York
Federal Reserve's consumer expectations survey
found that the share of respondents reporting this
has hit a new high.
While some experts are describing the current
situation as a "credit squeeze," others warn that if
left unchecked, it could escalate into a full-blown
credit crunch, leading to more stringent lending
standards and making it harder and more expensive
for consumers and businesses to obtain loans.
It's important to note that a credit crunch can have
far-reaching consequences, affecting everything
from small businesses to large corporations, and
potentially leading to widespread job losses and a
drop in economic growth.
However, it's worth noting that the situation is still
developing, and it's not yet clear whether a credit
crunch is imminent. Nonetheless, investors are
advised to stay vigilant and keep a close eye on
market developments to stay ahead of potential risks.
So, what's driving credit crunch fears?
Banking turmoil:
The recent collapse of Silicon Valley Bank and
Signature Bank has raised concerns about the
possibility of regional US banks facing similar
troubles. The withdrawal of funds by depositors has
led to a surge in the movement of funds from regional
banks to money-market funds, which are perceived to
be safer and offer better yields than uninsured
deposits.
This trend has resulted in an outflow of approximately
$120 billion in deposits from small banks in just one
week, according to Federal Reserve data released on
Friday. This deposit outflow has sparked worries
among investors that regional banks may face "bank
runs," which could lead to a credit crunch if lenders
become wary and pull back to limit their exposure.
Ian Shepherdson, chief economist at Pantheon
Macroeconomics, commented in a recent CNBC
interview that this trend of deposit outflows from
banks and inflows to money-market funds could lead
to banks halting lending activities in order to survive.
The potential impact of a credit crunch could be
significant, with businesses and consumers finding it
harder and more expensive to obtain loans.
It is worth noting that while concerns are mounting,
it is not yet clear whether a credit crunch is
imminent. Nonetheless, it is crucial for investors and
bank management to remain vigilant and closely
monitor market developments to stay ahead of
potential risks.
Higher interest rates:
The US Federal Reserve's decision to raise interest
rates to as high as 5% from almost zero in the past
year has caused concern about a potential credit
crunch. The steepest increase in US borrowing costs
since the 1980s is an attempt to rein in surging
inflation, but it has also increased the risk for mid-
sized and smaller lenders, leading to a flight of
deposits. According to JPMorgan, around $1 trillion in
deposits have been withdrawn from the "most
vulnerable US banks" since the Fed began raising
interest rates in March 2022.
This outflow of deposits could lead to a tightening of
lending standards as banks become more cautious.
High interest rates have also caused an increase in
borrowing costs, which could result in borrowers
being unable to repay their loans, increasing the risk
of loan defaults. The decline in the value of banks'
bonds and other assets due to higher rates is also a
cause for concern, specifically in the commercial
real-estate business.
Prominent figures such as Bill Gross and Jeffrey
Gundlach have warned about the potential impact of
higher rates on banks' balance sheets, as well as their
exposure to greater risks of loan defaults. However, it
is unclear how much the spate of bank failures that
have already occurred will lead to a general
contraction in credit. Experts predict that the Fed is
unlikely to cut rates until December 2023, which
could mean further issues in the meantime.
The impact of a credit crunch could be significant,
with businesses and consumers finding it harder and
more expensive to obtain loans. It is important for
investors and bank management to closely monitor
the situation and be prepared to take proactive steps
to mitigate any potential risks.
Fed uncertainty:
The possibility of tighter lending standards creates a
challenge for the US central bank, making it difficult
to predict how much of an impact further rate hikes
could have on credit and economic growth. As Preston
Caldwell, chief US economist at Morningstar
Research, pointed out, "The credit crunch
complicates the Fed's job because it creates
uncertainty about the sensitivity of the economy to
changes in monetary policy." The Fed will have to
navigate this delicate balance carefully to prevent a
potential credit crunch from turning into a broader
recession.
Recession risks:
If a credit crunch leads to a spike in loan defaults and
bankruptcies, it could seriously damage banks and
the wider financial system, potentially exacerbating
the economic downturn. The credit crunch poses a
considerable challenge for the US central bank,
complicating its efforts to determine the sensitivity of
the economy to changes in monetary policy. All in all,
investors and economists are keeping a close eye on
how this situation will unfold and its impact on the US
economy.
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