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 Fed Chair Janet Yellen said this week it was still too soon for the
central bank to change its view that rate hikes are needed, a
position supported by a still-robust pace of hiring that is helping
consumers borrow more readily.
But a tightening of lending standards for U.S. businesses and rising
corporate credit spreads suggest global financial market turmoil
could lead the Fed next month to signal fewer rate hikes this year
than the four increases policymakers signaled in December.
"Financial conditions are tightening the Fed's belt," Deutsche Bank,
which expects one rate increase this year, said in a note to clients
on Friday.
A net 4.2 percent of banks tightened standards on U.S. commercial
and industrial loans to small firms in the fourth quarter, the
highest level since late 2009, when the United States was just
emerging from a deep recession, according to the Fed's Senior Loan
Officer Opinion Survey.
While U.S. banks are still making it easier to get credit cards,
tighter credit standards for small companies suggest global
financial stress is spreading beyond export-oriented U.S. companies.
The question facing the Fed is: How much further will the tightening
spread?
Yellen told lawmakers on Wednesday the Fed was assessing the
potential impact from tighter lending standards and widening
corporate credit spreads but said it was "premature" to decide
whether the global shocks could change the interest rate outlook.
"It depends in part on whether they persist," she told lawmakers at
a second hearing on Thursday.
The Fed was in a similar situation in September, when plunging
global equity markets - including a 9 percent drop in the S&P 500 in
the prior two months - and worries about China's economy helped
convince policymakers to hold off on a rate hike.
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Financial markets subsequently recovered and the Fed went on to
raise rates in December and signal expectations of four more
increases in 2016.
Since then, global markets have soured once again, with European
banking shares hit by concerns over Deutsche Bank's financial health
and the potential for a recession in China, the world's
second-largest economy.
Prices for Federal Funds futures <0#FF> suggest investors do not
expect any rate hikes this year. Tighter lending standards were a
factor leading JPMorgan to increase its view of the chance of a
recession in the next 12 months to 32 percent from 21 percent in
mid-January.
Also worrisome for Yellen, investment-grade U.S. corporations are
paying higher interest rates on bonds relative to U.S. government
debt <.MERC0A0> even though companies are readily accessing bond
markets and overall banking credit grew more than 7 percent in the
year through Jan. 27, according to Fed data.
"A plausible downside risk to the economy is that tougher financial
conditions cause firms to slow capital spending and hiring," said
Goldman Sachs economist Zach Pandl. "The corporate sector looks
comparatively more vulnerable."
(Reporting by Jason Lange in Washington; Editing by Dan Grebler)
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