- A slowdown in US loan growth has been cited as a concern for near-term GDP growth. Commercial and industrial loan growth has slowed significantly leading to uncertainty around future growth of business investment, which has already lagged the US economic recovery.
- However, corporate loan growth is not necessarily a forward-looking growth indicator. Loan growth actually tends to lag GDP growth. At the start of an economic recovery, credit demand remains subdued until confidence lifts. A recovery in profit growth at the beginning of an upswing also means lower reliance on credit channels. The pick up in credit growth will therefore occur after economic activity has already lifted.
- So, slower loan growth is not necessarily symptomatic of a looming US growth downturn. The current episode of weakening credit growth looks to be a reflection of the US economy a year ago, when an improving growth backdrop allowed profits to increase, leading to lower demand for bank credit. As well, there looks to have been a negative impact on corporate credit demand from the energy capex collapse after the oil price plunged.
- There is still good momentum in the US economy, despite higher interest rates and disappointment around higher infrastructure spending and taxation reform.
The signs of a positive turn in the US economy started to become clear in 2016 and the prospect of government-led infrastructure spending, tax cuts and reduced regulation post-election added additional fuel to already elevated growth expectations. Since then, a re-evaluation of a realistic timeframe for fiscal spending and taxation reform by market participants and a slowing in some US data prints has cast doubt on the strength of the economic recovery. A sharp slowing in credit growth since early 2017 has been part of these fears, with concerns centring around a potential US growth slowdown and a Federal Reserve (Fed) policy mistake.
What is the credit data signalling?
The Fed release weekly data on the balance sheets of commercial banks which includes the stock of bank credit (bank loans and leases). The strength of loan growth is cited as a signal of corporate and consumer willingness to spend in the future with businesses and households more likely to take on additional debt when expectations about the future are positive, leading to increased appetite for goods and services spending.
The slowdown in credit growth over the past 3-4 months has been predominately focussed in commercial and industrial loans as well as “other loans” which includes non-traditional corporate and consumer loans (see chart below). Other loan growth has been declining steadily since 2015, so there is probably a structural (rather than cyclical) element working to slow growth in this component.
Source: Bloomberg, AMP Capital
Across the other sectors (real estate and consumer loans), a slowdown in lending growth is also evident, but to a lesser extent. Residential real estate lending growth is relatively unchanged to levels in 2016 and commercial real estate growth has tracked a little lower. Consumer loan growth has slowed, but not to an alarming rate. And other indicators of consumer spending are still okay – sentiment is strong, other measures of consumer credit growth are holding up and wages growth is lifting. However, lending standards have tightened for consumers (see chart below), probably in line with Fed interest rate hikes.
Source: Bloomberg, AMP Capital
Consumer spending is typically sensitive to interest rate changes and lending standard adjustments, so some weakening in consumer credit demand is understandable. Corporate lending standards have also become more constrained, but to a lesser degree than consumers, and have actually been moving towards easier conditions recently.
In that context, the significant weakening in corporate credit demand appears at odds with a better growth outlook, relatively neutral lending standards and low interest rates. The outlook for corporate sentiment and growth is particularly important for advanced economies that have struggled to lift business investment post the Financial Crisis in 2008-09.
Is slower credit growth symptomatic of a bigger growth problem?
Is the downturn in credit telling us of a looming downturn in the economy? If we look at previous credit and growth cycles, we find that GDP growth (orange line below) actually tends to lead loan growth (dark blue line below) by around a year, and this relationship is most evident around the peaks and troughs in economic activity. So, credit demand should not necessarily be viewed as a forward looking guide to spending.
Source: Reuters, Bloomberg, AMP Capital
This relationship between GDP and loan growth is best illustrated at turning points in the economy (i.e. economic booms and economic troughs). If an economy is starting to recover after a trough, credit demand will still remain subdued until there is stronger confidence for a sustained recovery. A recovering economy also means better profit growth, that lowers reliance on credit channels (like bank lending). This results in a pick up in credit growth occurring after economic growth has already lifted. Vice versa, at the beginning of a downturn, credit demand normally only starts to decline after slower economic momentum is evident. Profit growth also begins to decline which increases reliance on credit channels which means that credit growth will lag activity in the economy, and reach a bottom after the economic trough has already passed.
The current weakness in loan growth reflects activity in the US economy a year ago when GDP and profit growth were only starting to improve following the earlier slump in energy capex after oil prices plunged. A recovery in profits lowered reliance on bank credit (as firms turned to internally generated revenue to fund expenditure) and this lowered demand for bank loans, (which takes time to work through the economy) and is now reflected in the loan data. The energy capex collapse in 2016 would have also resulted in lower loan demand.
Now that the US economy is mid-cycle in its upswing, businesses may be more confident in their growth outlook and projections and profit growth are more or less stable at current growth rates, the reliance on credit funding should improve from current levels.
What about other sources of funding?
Besides bank credit, there are other sources of financing for corporates including using retained profits, equity financing or other forms of debt financing (i.e. issuing more bonds).
Have corporates taken to using other forms of funding besides the traditional bank loan? The data would suggest that there has been limited use of retained earnings (probably because shareholders are still demanding high dividend payouts in the search for yield). Net corporate bond issuance (excluding refinancing) would suggest limited growth in bond financing. So it doesn’t appear that corporates have taken on non-traditional funding channels just yet.
What is the US growth outlook?
The Federal Reserve has been slow and careful in hiking interest rates because the growth recovery is still in its early stages. Despite higher interest rates, the broad reading on activity indictors (consumer spending, business conditions and housing) are still showing stronger growth in 2017/18. Despite Fed rate hikes, interest rates are still very low in the historical context which is positive for debt-holders. At the same time, interest rate rises will benefit savers in the economy who have struggled in the low-interest rate environment. We still see US growth on track to be around 2.5% in 2017, well above the 1.6% recorded in 2016.
A lot of the disappointment around the US growth recovery recently has been around expectations for taxation reform, regulation cuts and infrastructure from the Trump administration which have yet to be finalised and passed through Congress. We still see corporate and individual tax rate cuts being passed in 2017 which is another driver for stronger growth.
Implications for investors
Despite some investor disappointment around the strength of the US recovery, growth momentum is well above levels a year ago and the corporate sector still looks healthy (stronger profits, solid PMI’s and positive confidence around the outlook). While inflation readings have been rather disappointing recently, better growth and a tightening labour market will start to bring down excess capacity which will be positive for inflation.
The rally in US equities over the past year reflects the positivity in the US outlook. A stronger US economy is important for global growth through trade and market sentiment linkages. With the US Fed becoming the first major global central bank to raise interest rates from extraordinarily low settings, other global central banks are starting to slowly become more hawkish as the period of ultra-accommodative policy settings is no longer required. Investors need to keep in mind that US equities have already rallied significantly on the back of improving growth momentum and expectations for stronger growth (led by fiscal expenditure and taxation reform). As a result, US equity valuations are now looking a bit stretched. We continue to favour Eurozone and Japanese equities which are experiencing both recovering economies with central banks still pursuing asset purchasing programs (albeit at a lower pace) without the stretched valuations in equity markets.
Credit data is a lagged indicator of economic performance. The recent slowdown in US loan growth is not changing our expectation that the US economic recovery is still on track over 2017/18. A recovery in US capital expenditure and a better consumer backdrop are important factors that will lead to a stronger US economy, before considering any potential upside stimulus from the government. Interest rates hikes will become a headwind to growth only when interest rates are tightened well beyond current levels (probably somewhere around 3%).
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