Market Week: May 15, 2023

The week in review

  • Headline/Core CPI, NSA: 4.9%/5.5% y/y
  • Initial jobless claims: 264K, up from 242K

The week ahead

  • Retail sales

Following the Federal Reserve’s (Fed’s) decision to raise the federal funds rate to a range of 5.00%-5.25%, investors scoured April’s CPI report and the 1Q Senior Loan Officer Survey in an attempt to get a sense of the Fed’s next steps.

Although the survey showed only a slight increase in the share of domestic banks reporting tighter lending standards, there is more to this than meets the eye. As shown in the chart of the week, banks had been incrementally tightening lending standards over the past year, and well before stress in the banking system began to emerge. While the share of banks tightening has not eclipsed pandemic levels, demand for commercial loans has fallen below levels seen during the depths of the pandemic. This has been particularly true among the regional banks, which have increased lending costs amidst an uncertain economic outlook and recent deposit flight.

The silver lining, however, is that tighter lending standards weigh on economic growth by depressing credit demand, and typically lead inflation to decelerate with a lag of 4-6 quarters. As such, the full impact of the tighter credit conditions is yet to be felt, but the April CPI report suggested that inflation is cooling, with year-over-year headline CPI moderating for the 10th consecutive month. Furthermore, after stripping out the volatile energy and lagging shelter components, services prices registered an increase of 0.11% on the month; this was the smallest increase since July 2022 and suggests that even some of the sticky components are beginning to turn over.

Looking ahead, further deceleration in inflation seems likely. However, the lagged impact of extremely tight monetary policy will begin to be felt more acutely and has raised the risk of recession later this year. As the growth/inflation mix begins to shift, it seems likely that the Fed’s resolve to keep rates higher for longer will be tested.

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