The Treasury Department. Foto: Ting Shen/Bloomberg
There has been a jubilant mood on the stock markets since the Fed announced the prospect of a shift in its interest rate policy. The markets are now assuming a Goldilocks scenario: declining inflation, a soft landing of the economy and significantly falling interest rates in 2024. But for all the euphoria about the Fed pivot, the market is ignoring the dangers that still lie beneath the surface slumber. The high costs of loans are affecting more and more debts that will come due in the coming years. This could lead to defaults and losses for banks and lenders, thereby triggering a credit event. Especially if central banks start cutting interest rates too late.
While Wall Street prices are surging on hopes of interest rate cuts in 2024, the real world is still dealing with the full weight of central bank tightening, according to Bloomberg.
In the last two years, central banks have rapidly raised interest rates and squeezed money out of the market Inflation to bring under control. That has made borrowing more expensive for governments, businesses and consumers and will hit spending well into next year.
“The bottom line is that the Fed’s many rate hikes are starting to have an impact and will continue to do so in 2024,” said Torsten Slok, chief economist at Apollo Global Management. “The restrictive monetary policy will not disappear as soon as the market expects.”
Interest rates will hit in 2024
As higher interest rates ripple through economies, Bloomberg Economics predicts 2024 will be the weakest non-crisis year since the start of the century. Huge debts will come due in the coming years, leading to defaults and losses for banks and lenders. Even if central banks achieve a soft landing, refinancing may be too costly for some companies. Access to credit has already become much more difficult for consumers, while regional banks have come under severe pressure from falling commercial property valuations.
The question now is whether the major central banks such as the Fed and ECB, which have long underestimated the risk of inflation, will cut interest rates too late in order to slow the looming downturn.
The charts below show the stresses that credit markets face when the effects of rising interest rates ripple through to the real economy.
An analysis by economists at Citigroup earlier this year found that worsening credit availability found in credit surveys in the U.S. and euro area could reduce real growth in both regions by about 1% to 2% by the end of next year. Stuart Paul, an economist at Bloomberg Economics, expects “spending in interest rate-sensitive categories to continue to decline as the effects of monetary policy continue to take hold.”
Recession indicator: Commercial and industrial credit demand remains negative. Dangers are downplayed
Nonetheless, some economists are downplaying the idea that the pain from central banks’ tightening policy will continue, while the pessimistic camp of recession forecasters has shrunk.
Regardless, it was a particularly dire time for households, whose incomes were eroded by the soaring costs of goods and services, as well as higher rental costs and credit card debt.
After two years of inflation, it is understandable that consumers are struggling to make ends meet,” Nestle CEO Mark Schneider said on Bloomberg TV. In addition, the Fed’s restrictive measures “are now finding their way into the real economy. “You see mortgage rates going up, you see rents going up, and all of that is leading to a lot of consumer caution.”
The pressure on consumers, especially those with low incomes, is reflected in credit card delinquencies that have risen above pre-pandemic levels and record delinquencies on subprime auto loans.
U.S. consumers say credit is much harder to get
Effects of Fed interest rate policy
“We’ve seen banks tighten their lending standards at a pace that is historically consistent with a recession,” said Shannon Seery Grein, an economist at Wells Fargo. “Even if the Fed begins to ease monetary policy, it will take time for the more favorable conditions to be felt in the economy and in consumer borrowing costs.
Companies are also slowly feeling the effects of the uncertain outlook and the pressure on income.
Toy maker Hasbro plans to lay off 20% of its workforce amid slumping holiday sales, while Ford is cutting production targets for its signature electric vehicle, in part because customers balk at high prices. Walgreen Boots Alliance was downgraded to junk status by Moody’s this month, citing weak consumer conditions, among other factors.
Morgan Stanley strategists, including Vishwas Patkar, expect further corporate bond downgrades to occur “as the lagged effects of the Fed’s hawkish interest rate policy continue to play out” and impact both the cash flow of poorly performing companies and their ability to generate their debt paying debts.
Bank collapses
Even if Wall Street says that nothing went wrong this year, 2023 still saw the collapse of a globally systemically important bank, Credit Suisse. In addition, various regional credit institutions in the US have faltered, requiring the intervention of major banks, the government and regulators to prevent further contagion in the banking sector.
The run on banks came after losses in securities portfolios, while the default on commercial real estate loans will weigh on many of these smaller lenders for years to come.
According to Trepp, more than $2.8 trillion in U.S. commercial real estate loans will come due between next year and 2028, the majority of which will be held by banks. A 35% drop in office values since their peak means lenders face billions of dollars in losses as their loans come up for refinancing.
Fitch forecasts delinquencies on U.S. commercial mortgage-backed security (CMBS) loans will increase to 8.1% in 2024 and 9.9% in 2025.
In a study released this month by the National Bureau of Economic Research, researchers including Erica Xuewei Jiang said that “the U.S. banking system will face significant risk of insolvency for an extended period of time as long as interest rates remain high.”
Banks: Almost $3 trillion in US real estate debt is due by 2028Euro area: Tightened lending
The framework conditions for lending have also changed in the euro area: banks have significantly held back on granting loans and are also confronted with losses on commercial real estate.
Lending standards have tightened as the worsening economic outlook limits lenders’ risk tolerance. Banks demand higher credit margins because market interest rates have an impact on the real economy. Meanwhile, borrowers are more likely to try to reduce their debts than take out additional loans to finance investments.
The transition from quantitative easing to central bank tightening has also impacted credit conditions. A trend that banks believe will continue into next year and reduce liquidity. That could trigger a race to the bottom in lending worldwide, leading to systemic problems, Moody’s Investors Service warned in September.
Banks have been restricting the flow of new money to European companies by 99% since 2020. Increases in credit costs are becoming a problem
The return of a bankruptcy cycle after the end of the cheap money era could also engulf some CCC-rated bond issuers that have been kept afloat by lower interest rates during the pandemic. While the bond universe is small at less than $176 billion, it is still well above levels during the financial crisis, when bankruptcies skyrocketed.
Companies with this rating face significantly higher borrowing costs when their debt needs to be refinanced. They also face a potential decline in customers, which will impact their profits in an economic slowdown.
Risky companies face a massive increase in borrowing costs
Spreads between these securities, which have relatively high risk of default, and other corporate bonds have not narrowed after Fed Chair Jerome Powell’s dovish comments last week, a sign that bondholders remain risk-averse.
At some point there will be a reckoning and with it “dramatic repricings” because the credit market as a whole is more biased than ever toward lower-quality issuers, JPMorgan Asset Management’s Oksana Aronov said on Bloomberg TV this month.
“There are companies that weren’t supposed to make it past 2020 and won’t make it now because the Fed isn’t supporting them,” she said.
FMW/Bloomberg
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2023-12-22 09:44:31
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