Any thoughts on how to gauge the slowdown in lending which is supposed to be equivalent to a FFR increase? For additional background - Take aways from Powell's last announcement
-Powell predicted that banks are going to tighten lending. At another point he said that if that prediction didn't occur, we might need more rate hikes. In another answer, he said bank credit tightening will "substitute for rate hikes". This is an admission that the bank squeeze will be doing the Fed's work for them, and a rationale for pausing rate hikes below the 12-month rate of inflation. He left open the possibility that banks won't tighten their lending, and I can see reasons why that might occur.
I'm watching the FedWatch Tool which has crept toward another 25 bps hike May 3rd, but that may be in response to the increase in oil price...
I agree that the bank squeeze will tighten lending, as banks will need to hold extra cash to guard against the risk of bank runs. In practical terms that means accepting loan and interest payments but not loaning that money back out right away.
As
@chasesfish noted above, any time a bank can take in a payment on a low-interest-rate loan, and redeploy those funds into a high-interest-rate loan, they adjust their asset base incrementally closer to returning a high interest rate. Resetting the asset base is eventually necessary because the banks' cost of capital rises as interest rates continue to rise. I just loaned some capital to a couple of banks at 5.2% interest, and those banks are probably holding lots of 3-4% loans and bonds.
So banks are torn right now between the need to raise cash by
not making loans, and the need to
make new loans to reset their asset base to match higher interest rates. Hoarding cash resolves the immediate risk of bank runs, but it worsens the long-run risk of having to pay depositors higher rates than their loan and securities portfolios yield.
The new federal credit facility addresses the risk of bank runs, but it only buys time for banks that eventually need to recycle some capital into new loans and securities.
The risk is that a recession could stop people from buying houses, cars, kitchen remodels, business equipment, card purchases, and so forth. Also during a recession, businesses will reduce their deposit base - e.g. the payroll account needs less funds when you go from 50 to 20 employees and businesses will face challenges matching the timing of their receivables with their payables. At that point, the banks will lose the option to replace old loans with new, because the loan demand will dry up.
If rates were to continue rising and banks are unable to reset their asset base to match those higher rates, we'll see bank bankruptcies instead of bank runs. Banks will be liquid thanks to the federal loan program, but their lack of profitability will send equity into the negative.
That's why I think the futures markets might be wrong about a May rate hike. JPow could justify a pause at this point by saying (a) he warned about a pause in March, (b) monthly inflation has been falling for the past several months, (c) he doesn't want to add pressure to banks, (d) we can always raise rates at a more cautious pace in the coming months, and (e) bank stresses are expected to match the effect of positive real interest rates.
Of course, that's the *right* thing to do, IMO, not the thing the FOMC will *actually* do. So far Fed officials seem to be compartmentalizing the inflation and bank run problems, and treating them separately. Powell's insistence at the last press conference that the bank loan program isn't QE reflects this thought dynamic.
I've not been this uncertain about the Fed's next move for the past 12 months. I considered dropping some play money into a long straddle or strangle on XLF or KRE because pause or hike, financial stocks should move big on May 3.
