Spring is supposed to be arriving, however, at least here in the North there is no evidence of any break in the cold, snowy weather. By now we should have some of the early green shoots of tree buds, daffodils and other signs of a change in season, but nothing so far.
The economic reports this past week point to the green shoots of a softening economy. These numbers all predate the massive impact that the crisis in our banking system of the past week. Let’s start with the banking issues and the impact they will have in the coming months.
The key ignitors to the current banking issues is the mark to market write down of investments causing concerns over levels of equity as well the run on deposits. I want to be clear, I have been warning bankers about the deposit run off since last June. The peak deposit level in the banking industry was hit on April 13, 2022. From October of last year to March 8, before the SVB impact, deposits have fallen 2.6% in the system. In the past week that has only eroded further.
This drop will not ebb and will likely continue. This will lead to a period of disintermediation where the banks liquidity will limit the amount of lending they will be able to do. Smart banks are already assessing their credit portfolio, highlighting the best, most important clients and setting aside dry powder to make sure they meet their needs. Periods of disintermediation have always produced recessions as companies are unable to expand or in many cases even stay in business without the ability to borrow. My estimation is that we will see this impact in the second quarter of 2023.
The economic reports show that a softening economy is already taking root. Both the New York Empire Manufacturing Index and Philly Manufacturing report were strongly negative. That is the second month in a row, again, following a number of other FED manufacturing reports where the numbers are reflective of a significant roll back. The manufacturing sector is currently living off of the back log of orders that originated late last year. New orders are falling off dramatically. For the moment, layoffs are rare, but as the back log is caught up, staff cuts are going to begin.
Industrial production was flat in February, continuing a nine month trend of lackluster, even negative numbers. Capacity utilization remains well beneath a level that would promote new investment. Currently capacity is at 78%. 81% is the lower threshold where companies would likely invest in new equipment to become more efficient.
The month over month inflation rate for February was .4%. For the past 8 months, the month over month numbers are running at an annualized rate of 3.4%. This is still high. However, the prior 8 months had inflation on a month over month basis running at over 9% annually. The fever appears to have broken in June of last year, which was roughly 15 months after the Fed’s first rate increase. What can be said so far is that we have picked the low hanging fruit of reducing inflation. Dropping to 2%, another 1.4% will likely be more painful than what we have experienced so far in terms of economic activity. Between another rate hike and a coming recession by the third quarter this year, the inflation monster may be on the verge of being controlled, it just will not be pleasant.
Retail sales for February fell across the board. Consumers appear to be cutting back and retrenching. This is likely the result of personal budgets being stressed. Consumers have been drawing down savings while at the same time seeing revolving debt increase. They appear to be recognizing that the pattern will continue unless they cut back.
My last point is that for now bank portfolios appear stable. Smart banks are not looking at their past due reports as a measure for the quality in the credit portfolio. They are working closely with their clients and watching individual deposit levels to see where the cash shortfalls may lie in the near future. A past due payment is not an early warning sign, but an indication your client is already out of money and you have lost the opportunity to address the issue and solve their problem. If you are a lender, this is the time to be proactive
Have a great week