According to the latest data released on September 9, 2016, by the Federal Reserve, the 12-week change in commercial and industrial (C&I) loans for all U.S. commercial banks turned negative in the week ending August 31, 2016. Such poor performance should be taken cautiously as negative growth in C&I loans over a 3-month horizon has historically tended to coincide with recessions (see the chart below).
Such results are also in-line with the July 2016 Senior Loan Officer Opinion Survey on Bank Lending Practices, which showed that a net 8.5% of banks reported tightening standards for C&I loans to large and middle-market firms over the second quarter, while a net 7.1% of respondents reported tightening standards for small business lending. This was the fourth consecutive quarter with banks tightening standards for C&I loans.
While recent changes in C&I loans do not portray a U.S. economy in great shape, we remain of the view that a recession isn’t right around the corner. The negative 3-month change in C&I loans is more emblematic of an economic slowdown than a recession, in our view. Indeed, employment continues to expand at a solid pace with a 182,000 average monthly gains year-to-date and the year-over-year change in initial jobless claims remains in negative territory.
Moreover, total labor income continues to grow at a historically high 3.2%, in real terms. The drop-off in profit margins also appears to be behind us, with the S&P 500 12-month forward profit margin now back on the rise, which should contribute to a re-acceleration of earnings growth by year-end.
Nonetheless, it is interesting to note that since 1990, the Federal Reserve never raised interest rates when the 3-month change in C&I loans was in negative territory. Our base-case scenario remains for a December rate hike. However, we will closely monitor changes in C&I loans over the next few weeks as further deterioration in loan growth could lead us to postpone our timing for the next rate hike.
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