Bank stress continues, but labour trends are good

Inflation is falling and house sales and prices are climbing as recession-watch continues

Bank stress continues, but labour trends are good

Weeks after two U.S. regional banks failed, there is still stress in the banking system and some cautionary notes for advisors. 

Eric Lascelles, chief economist at RBC Global Asset Management, noted several trends to watch in the U.S. banks and North American economies.

When the recent banking news hit the U.S., many deposits fled the system and have not returned. Demand for emergency loans from the Fed., however, have begun to decline, though financial institutions still use them.

“As for the level of concern in the financial markets about banks, in general – as to whether they will be able to repay their debt,” said Lascelles, “this has significantly eased. It was never anything like the level of concern expressed about banks during the global financial crisis of 2008-2009.”

But he noted that many banks still lost a lot of money on their bond holdings as interest rates rose. That, combined with the deposit outflow, has left them less liquid and more capital-constrained than usual. Banks were already tightening their lending standards before this latest bank crisis, and he expects that to increase.

There are also early signs of ebbing U.S. credit growth, and Lascelles said “a sharply rising fraction of U.S. small businesses now expect tighter credit ahead.”

Lending and loan demand for both businesses and consumers has declined in recent months. While many areas of the U.S. reported tighter lending standards because of greater uncertainty and liquidity concerns, he particularly noted that the New York region said conditions had “deteriorated sharply”.

Lascelles expects that more constrained bank credit could result in some economic damage, particularly for mid-sized and smaller business that rely on the banks. While he noted this will reduce the implications for stock and bond-market investors, there could still be some impact on larger entities.

He also said there could be some continued chill on regional U.S. banks for several years since depositors now are more skittish about the bank sector’s risk, so they may have a longer-term preference for the relative stability of larger institutions. He noted that the smaller U.S. banks are also about to be more regulated to avoid future problems, which will “reduce their regulatory advantage, cut their profitability, and pare their ability to lend.” That could impact the commercial real estate sector and smaller businesses, and an impending recession could further challenge those banks.

Other Trends

In other trends, Lascelles noted that, while most of the U.S. economic data remains steady, he pointed to a deceleration in consumer spending, manufacturing activity, transportation and freight volumes, and non-residential real estate. The U.S. labour force participation rate had also almost returned to its pre-global financial crisis level. 

“Put more simply,” said Lascelles, “the demand for labour rose quickly, but the supply of labour unexpectedly kept pace. People were presumably pulled back in by diminishing household savings, shrinking retirement account valuations, falling home prices, ebbing pandemic fears, strong wage growth, and the plethora of jobs available.”

While some strikes are already occurring in the United Kingdom and after Canada’s federal strike, Lascelles noted that the number of work stoppages in both Canada and the U.S. remained fairly low when compared to previous decades. While he suggested that there could be more, strikes to come he estimated that the risk is still moderate – particularly since U.S. mass layoffs and job cuts are beginning to rise, which is a traditional precursor to economy-wide job losses and a recession.

In good news, he said he expects inflation to fall slightly more quickly than the market is assuming since the U.S., Canadian, and Eurozone inflation rates have all fallen in the past eight months. North America’s are now more than half of the way back to normal. While the United Kingdom has had a rockier road, he said, that now appears to be declining as well. He predicted that both the U.S. and Canadian inflation rates will drop to about 3% year-over-year in June, much better than the previous 8% to 10%, and closer to the banks’ desired 2%.

Finally, Canadian home sales have also risen slightly and Canadian home prices are rebounding across the country, but Lascelles said, “the question is whether this is the beginning of a genuine recovery or merely a seasonal blip”.