February pull-back widens the entry point for fixed income
Last week we looked at data showing US banks were tightening financial conditions , and what that could mean for the economy (and for markets) going forward.
Now we’re going to look at similar data for the Eurozone, but there a few differences worth mentioning first. One difference is on the macro side. The European Central Bank was the last of the major central banks (excluding the Bank of Japan) to start tightening monetary policy in 2022, its first rate hike coming in July 2022 versus March 2022 for the Fed and December 2021 for the Bank of England. Looking at the Fed’s balance sheet, total assets reached a peak in April 2022 and have been steadily declining, while the ECB’s total assets have shrunk in a more discrete fashion as a result of its cheap TLTRO loans to banks rolling off. This is set to change in the next few months as the ECB embarks on more traditional (if we can call it that) quantitative tightening. The other difference is geopolitical. The ECB might have been more reluctant to tighten monetary policy shortly after Russia’s invasion of Ukraine, since the conflict was likely to have a larger economic impact in the Eurozone than in the US.
At the risk of oversimplifying, those two differences translate into an ECB tightening cycle that might be a couple of quarters behind that of the Fed. The chart below is based on data from the ECB’s Bank Lending Survey, and it plots the change in lending standards for businesses against total loans outstanding to non-financial corporations since the survey began in 2003.
A few interesting observations can be made here. Firstly, the post-Lehman experience of credit volumes was very different in the Eurozone compared to the US. While in the US corporate loans outstanding declined by over 25% peak-to-trough, they recovered relatively steeply and consistently once the trough was found, returning to their 2008 peak by 2014. In the Eurozone, loans outstanding declined by only 13% post-Lehman, but it was not until January 2022 that they regained the lost ground. Banks in the Eurozone were a lot slower in dealing with their non-performing loans exposures than in the US, partly because aggressive new regulation forced them to increase capital levels significantly, and they therefore weren’t ready to restart their lending volumes until much later. The impact this had on growth during the last decade or so has been evident.
Secondly, relative to history the tightening in lending standards post-COVID was much more severe in the US than in the Eurozone. US banks were not far away from their 2009 peak tightening on this metric, while in the Eurozone less than 30% of banks responded they were tightening lending standards back in Q1 2020. This compares to a peak of almost 70% in 2009, and just over 30% in the midst of the sovereign crisis in 2011.
Thirdly, at the moment, the ECB’s Bank Lending Survey shows 30% of Eurozone banks are again tightening lending standards, which is a large number in the context of the survey’s history and with the COVID and sovereign crisis periods in mind. This is starting to show up in lending volumes to corporates, though as the chart above shows there is a plateau forming at recent highs rather than a steep drop.
In our view, similar to the US, lending volumes in the Eurozone are showing the first signs of exhaustion. This is to be expected and actually likely to be welcomed by central bankers, who are desperately trying to tame aggregate demand in their respective jurisdictions in order to bring inflation down. Just as is the case in the US, stagnating lending volumes are a consequence both of banks constraining credit supply and of lower demand from firms and consumers as a result of weaker economic prospects.
In this context the ECB’s upcoming Summary of Economic Projections, which should be out by mid-March, is of the utmost importance. We will be looking with particular interest at the forecast for 2023 inflation. There is considerable uncertainty as to how ECB forecasters will factor in recent inflation prints that show little sign of core inflation receding, along with the stagnation in lending volumes and natural gas prices that are close to 70% lower than the last time they made their forecasts available to the public. We will keep you posted.