Credit conditions & inflation, Fed and RBA implications
In this Weekly we explore two key US themes we are tracking closely for the trajectory of rates and inflation, in both Australia and the US. As we have noted previously, trends in the US have generally led developments in Australia in this cycle by around 6-9 months given Australia’s later pivot to living with Covid. The first theme we are tracking is the tightening in credit conditions and to what extent that tightening impacts on activity and in turn inflation:
A key update on the tightening of US credit conditions was seen last week in the Senior Loan Officers Survey. Banks reported tighter standards and weaker demand for commercial/industrial loans. Banks that tightened standards cited a less favourable economic outlook, reduced tolerance for risk, worsening of industry-specific problems, and deterioration in expected liquidity.
It is still unclear to what degree the tightening in credit conditions will impact on activity and inflation. The Fed’s Goolsbee has cited estimates that convert the impact of tighter credit to the equivalent of “25bps to 150bps” worth of rate hikes. While Australia does not have a loan officers survey, the NAB Business Survey’s question on borrowing conditions has shown little change.
The second is the tentative positive signs on inflation with US inflation expectations having broadly eased in Q2, while core measures of inflation have decelerated:
Inflation expectations as measured by the Fed staff’s Common Inflation Expectations Index has decelerated rapidly in Q2 on our estimates, to be broadly back to where it was in 2014. The 3m annualised track of core measures has also decelerated, though the current rates still remain too high – the trimmed mean is now running at 4.2% and the core sticky excl. shelter is 3.6%.
Fed officials have mixed views on these developments, being very wary of being headfaked as they were back in late 2021 when inflation decelerated, only to re-accelerate once again. As Fed’s Kashkari noted: “Most importantly, we should not be fooled by a few months of positive data”. For markets, if US core inflation is decelerating, then services inflation may not be as sticky as feared. Sticky services inflation offshore was cited in the RBA Minutes today as once reason for hiking in May. While fears of overtightening should remain given the tightening in credit conditions and fall in loan demand.
Chart 1: Credit conditions have tightened, while loan demand has also fallen sharply
Chart 2: Fall in loan demand is across the board
Chart 3: Main reasons for tightening credit conditions are uncertain economic outlook and reduced tolerance for risk
Chart 4: Inflation expectations look less threatening
Chart 5: Core CPI appears to be decelerating, though is still above average levels