CREDIT LEADS: The Lending Spigot Is Quickly Constricting

Gordon T Long

Global Macro Research | Macro-Technical Analysis

TIPPING POINTS

CREDIT CONTRACTION

CREDIT LEADS: The Lending Spigot Is Quickly Constricting!

COMPOUNDING UNINTENDED CONSEQUENCES OF RUSSIAN SANCTIONS

Sustained central bank QT programs are likely (if carried out) to result in another major mortgage / housing debacle similar to 2008,
European Banks (specifically large Italian and French) are in serious trouble and may soon trigger another EU Banking Crisis due to the impact of sanctions on Russia. The banking crisis can be expected to be even worse than in 2012 as the problems then were only “papered” over with programs of easy money,
US Banks, though in better shape than EU banks can be expected to be impaled by failing EU banks and forced to tighten lending more than currently anticipated,
Dramatically reduced Bank stock buybacks will further complicate weakness in the US equity markets. Buybacks have been a primary contributor, along with excess liquidity, to the exaggerated market rise over the last decade.

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Russia’s war on Ukraine has dealt a new and serious blow to Globalization, just when the negative impact that Covid had delivered to Globalization appeared to be fading. As a direct result, Commodity Prices as an example have spiked to levels that would have been unimaginable before the war.

Over time, tighter sanctions will significantly reduce the export of Russian oil, gas, wheat, metals and other commodities. This will keep commodity prices high and, therefore, add to broader inflationary pressure in the US, Europe and all around the world.

Confronted with the probability of persistently high inflation, the Fed, ECB, BOE and many other central banks around the world have no choice but to tighten Monetary Policy much more aggressively than it had planned before the war began, DESPITE an obvious end of Business cycle and looming recession! The Inflation rate at 8.5% is likely to remain

elevated due to supply chain disruptions caused by Russia’s invasion of Ukraine and additionally the current major spreading of Covid within the major industrial and shipping heart of China. This is highly likely to force the Fed to continue tightening Monetary Policy, even if the stock market does fall sharply.

Russia’s war on Ukraine has set off a world crisis. It’s not yet certain if this is a turning point in history or only a temporary setback?

GLOBAL LIQUIDITY

FEDERAL RESERVE

A RISING FED FUNDS RATE

The Federal Reserve has already begun raising rates. A number of Fed governors have suggested that a 50-basis point rate hike is likely to be announced at the next meeting. The Fed meets next on May 3rd and 4th. It is expected that a 50-basis point rate hike in May will occur with another 50-basis point rate hike at the Fed’s following meeting in June and then a 25-basis point rate hike at every FOMC meeting after that, until mid-2023. Then by June next year, the Federal Funds Rate will be 3.3%. This is highly likely to crash both the US Equity Market as well as the US Housing Market!

QUANTITATIVE TIGHTENING (QT)

The Federal Reserve has additionally stated that its plans call for Quantitative Tightening which is the opposite of Quantitative Easing. With Quantitative Easing, the Fed creates Dollars and pumps them into the Financial Markets, which tends to push interest rates lower and asset prices higher. However, with Quantitative Tightening, the Fed removes Dollars from the Financial Markets and destroys them. That tends to push interest rates higher and asset prices lower.

The Minutes to the Fed’s March FOMC meeting (which were released on April 6th) suggested that the Fed is likely to launch Quantitative Tightening early next month (May).The Minutes also suggested the Fed planned to carry out QT at the

pace of $95 billion a month, although during the first couple of months it would phase in QT at a lower amount than $95 billion a month. It can be assumed that QT of $30 billion in May, $60 billion in June and then $95 billion a month every month after that, would mean that the Fed could destroy 1.25 trillion Dollars or 14% of all Dollars by the middle of 2023. That would reduce the size of the Fed’s Total Assets from $8.9 trillion now to around $7.7 trillion in June 2023.

IS THE FED ABOUT TO TRIGGER ANOTHER HOUSING / MORTGAGE DEBACLE??

The 30-Year Fixed Mortgage Rate has moved up by 180 basis points so far this year and is already being felt in mortgage originations. This is going to get MUCH worse … SOON!

US FINANCIAL SECTOR (Banks, Lending Institutions and Financial Intermediaries)

ECB

It is currently expected that the European Central Bank’s (ECB) balance sheet will actually shrink faster than the Fed’s from May 2022 to May 2023, given less liquidity via TLTROs. This is because of the ECB’s ultra-cheap and unlimited funding provision to euro zone banks. The monthly net purchases under the APP (Asset Purchase Program of Corporate and Covered Bonds from banks) will result in decreasing amounts of €40 billion in April, €30 billion in May and €20 billion in June. (See EU Bank problems below.)

GLOBAL CENTRAL BANKS

According to Morgan Stanley, the world’s top central banks are about to embark on “the largest quantitative tightening in history”, estimating that $2.2 trillion worth of support would disappear over the next 12 months. A surge in global inflation is forcing the European Central Bank, Bank of Japan and Bank of England (BoE) to reel in the support measures used during the coronavirus pandemic. This week has also seen the BoE raise its rates for the second time in three months, while the ECB has fanned bets that it will deliver its first hike in a decade. Morgan Stanley further said: “G4 central bank balance sheets will peak in May, adding the $2.2 trillion reduction they expected would be 4.5 times larger that in 2018 when the around $500 billion was lost.”

CREDIT

In the 21st century, Liquidity determines the direction of asset prices. However, CREDIT growth drives economic growth. Much tighter Monetary Policy will cause Credit Growth to slow sharply and possibly contract. Therefore, the chances of many countries, including the US, falling into Recession are now significant. The recent inversion of the yield curve supports this view as it is normally a precursor of a Recession.

HAVE SANCTIONS FURTHER DESTABILIZED THE EU BANKING SECTOR?

Sovereign, Corporate IG and HY bond prices are collapsing and with them their collateral supporting loans, VaR (Value-at-Risk) exposures as well as short term counterparts funding exposures. (See the 10Y US Treasury Yield spike to the right which collapses prices.)

Together they have the potential to take down the whole banking system in a cascading collateral failure from top to bottom. This is because they are all leveraged “to the gills” with seriously weakening bonds and financial assets as collateral. The consequences for the global banking system are potentially frightening!

The commercial banking networks with the highest leverage are in the Eurozone with its G-SIBs asset to equity ratios averaging over 21 times, with some considerably higher. The Japanese banks are also at about 21 times. Both the ECB and the BOJ have imposed negative interest rates, so the rise in global interest rates are bound to wipe out commercial bank capital in these jurisdictions first.

EU BANKS

The EU Banks are in trouble and highly likely to spill over into the US Banking Sector!

Major US Banks are increasingly worried about contagion and counter-party risk!

The technical analysis patterns are highly suggestive to be potential repeats of the impact of Covid-19 and possibly even much worse!

EU BANKS ARE CLEARLY SENDING SIGNALS OF POTENTIAL CREDIT STRESS!

ITALIAN BANKS

The largest Italian banks like Unicredit (chart above) and Intesa Sanpaolo are feeling the direct impact of Russia! The collapse is frightening in its degree and speed. It is making other major banks worried!

FRENCH BANKS

The largest French banks like Societe Generale (chart above), Credit Agricole and BNP Paribas are also feeling the direct impact of Russia! Compounded with the Italian banks It is making EU and US major banks pay close attention!

US BANKS

A WEAKENING BANKING SECTOR IS ALWAYS A MAJOR WARNING ABOUT MARKET DIRECTION

Of the big five US banks and bank holding companies by total assets – JP Morgan, Bank of America, Wells Fargo, Citigroup and Goldman Sachs Group – four reported Q1 earnings beginning April 14th, and with BofA finishing on April 18th. Earnings reports were marked by a sharp decline in revenues and net income.

The big five banks’ market capitalization has already plunged 23.5% since its recent peak in October 2021.

JP MORGAN

JPM accrued $902 million for loan loss reserves, compared to a $5.2-billion benefit a year ago from releasing loan loss reserves it had set up during the pandemic. Additionally JPM booked $582 million in net charge-offs, bringing the total credit costs to $1.5 billion.

GOLDMAN SACHS

Goldman set aside $561 million for credit losses, compared to a benefit of $70 million a year earlier.

“The rapidly evolving market environment had a significant effect on client activity as risk intermediation came to the fore and equity issuance came to a near standstill.”

Q1 EARNINGS RESULTS

JP MORGAN [JPM] Net income plunged by 42% to $8.3 billion in Q1 compared to Q1 last year. Revenues fell 5% to $30.7 billion, on a 35% plunge in revenues.
Goldman Sachs [GS] reported that revenues plunged 27% in Q1 to $12.9 billion, and net income plunged by 42% to $3.9 billion.
Citigroup [C] reported that revenues declined 2.5% to $19.2 billion. Net income plunged 46% to $4.3 billion, on higher operating expenses (+15%) and credit losses of $755 million, compared to a benefit of $2.05 billion a year earlier.
Wells Fargo [WFC] reported that revenues dropped 5% to $17.6 billion. Net income plunged 21% to $3.67 billion.

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HIGHLIGHTS

Significantly Increased Loan Loss Provisions:
- JPM: $902 million for loan loss reserves, compared to a $5.2-billion benefit a year ago from releasing loan loss reserves it had set up during the pandemic. It booked $582 million in net charge-offs, bringing the total credit costs to $1.5 billion.
- GOLDMAN: Set aside $561 million for credit losses, compared to a benefit of $70 million a year earlier.
Collapsing Investment Banking activity:
- JPM: Corporate & Investment Bank profits got hit by a $524 million loss, “driven by funding spread widening as well as credit valuation adjustments relating to both increases in commodities exposures and markdowns of derivatives receivables from Russia-associated counterparties”,
- GOLDMAN: Investment banking revenue plunged by 36% to $2.4 billion.
- CITI: “The current macro backdrop impacted Investment Banking as we saw a contraction in capital market activity. This remains a key area of investment for us”
Mortgage Lending :
- WELLS FARGO: Mortgage lending activity, plunged by 33% in the quarter on surging mortgage rates.
- “The Federal Reserve has made it clear that it will take actions necessary to reduce inflation and this will certainly reduce economic growth,” and “the war in Ukraine adds additional risk to the downside”
Reduced Lending;
- CITI: Asset management revenue collapsed by 88% to $546 million, “primarily reflecting net losses in Equity investments and significantly lower net revenues in Lending and debt investments.”
- GOLDMAN: “The rapidly evolving market environment had a significant effect on client activity as risk intermediation came to the fore and equity issuance came to a near standstill.”

CONCLUSION

Last week, the US Yield Curve inverted, meaning that the Yield on 2-Year government bonds rose above the Yield on 10-Year government bonds. When the Yield Curve inverts, Recessions typically follow.

My colleague Richard Duncan, (I highly recommend you subscribe using the MATASII promo code “FLOWS”), boils the current situation down to three major threats:

Asset Prices are extremely stretched relative to Income and therefore at risk of a sharp correction should any further unfavorable developments arise.
The Fed intends to tighten Monetary Policy aggressively during the rest of this year by hiking interest rates and by destroying extraordinarily large amounts of Dollars through Quantitative Tightening.
Credit Growth (adjusted for inflation) is likely to come in below the 2% Recession Threshold again this year, for the second year in a row.

MAJOR BUYBACK REDUCTIONS

The earnings debacle of the major US banks occurred amid enormous share buybacks. These banks have been regularly featured among the largest share buyback queens in the US, except during the pandemic, when they halted the practice for three quarters. In the five years from 2017 through 2021, the five banks have incinerated, wasted and destroyed $328 billion in cash on repurchasing their own shares to prop up their stocks, and now their stocks have nothing to show for it.

EXPECT BUYBACKS TO SLOW DRAMATICALLY TO PROTECT CASH NEEDS

A US RECESSION COMETH – Banks are Preparing!

All of the above along with an ineffective political response to the Ukraine conflict will push the US into a Recession in 2023 or earlier.

Not every recession is led by a 50% rise in crude.

But every 50% rise in crude has led a recession.

Jim Bianco biancoresearch.eth

@biancoresearch

Yield Curve is now Flat and Nearing Inversion

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