The week in the markets -
May 12, 2023

Debt ceiling drama casts shadow over inflation report

• April U.S. CPI data showed inflation continued its downward trend.
• Banks tightened lending standards for commercial and industrial loans.
• Ongoing debate on the U.S. debt ceiling has potential fallout for the economy if not resolved.
   

The U.S. Consumer Price Index (CPI) data for April showed that inflation continued its downward trend, rising by 0.4% month-over-month, with headline CPI up 4.9% year-over-year. This marked the first reading below 5% in two years. The core inflation reading, which excludes volatile food and energy prices, came in at 5.5% year-over-year. A second consecutive month of declining energy commodities has contributed to bringing down inflation, which is a positive sign heading into the summer months. Breaking down the various parts of consumer spending, services are trending downward, while goods purchases are slightly up. Airfares and hotel prices were lower for the month, along with new cars and durable goods.

The U.S. Federal Reserve's Senior Loan Officer Opinion Survey on Bank Lending Practices, conducted quarterly, provides a snapshot of U.S. banks' lending practices. The April report showed that banks had tightened lending standards for commercial and industrial loans, while standards for other loan categories remained largely unchanged. Mid-sized and other smaller banks cited concerns regarding their liquidity positions, deposit outflows and funding costs as reasons for tightening lending. Regarding demand for consumer loans, most banks reported weaker demand for auto loans, and some reported weaker demand for consumer loans. Demand for credit card loans remained mostly unchanged, even as delinquency rates on bank credit cards edged higher since their bottom in September 2021.

Banks have adjusted their willingness to take on risk and decreased the size of the loans that they’ll approve, in a move to protect their loan portfolio against potential future delinquencies. They’ve also increased the spread between the interest rate they charge and the cost of funds, making it more expensive for small and medium-sized firms to borrow. It’s clear that credit conditions have tightened for many businesses and consumers, and that will limit economic growth.

On our radar this week is the ongoing debate surrounding the U.S. statutory borrowing limit, also known as the debt ceiling. While this standoff has caused concern among investors, we maintain an optimistic outlook that a resolution will be reached in time to fulfill the U.S. government’s current obligations. While the U.S. Treasury is approaching the limit of the accounting manoeuvres available to it, defaulting on the debt would not be wise. The U.S. Federal Reserve has estimated that a temporary federal debt default could result in significant economic and financial consequences, including millions of job losses and a contraction of the economy into recession.