Debt markets are showing signs of strain building in the economy

The Federal Reserve’s tightening cycle is having an impact on the real economy. Their intention is for rising interest rates to slow spending in order to reduce inflation. Fed Chair Powell said that he expects this process to cause “some pain.” That pain is beginning to show.

Where Is the U.S. Economy Headed? Follow the Money

Debt markets, where lenders funnel money to businesses and consumers, are showing signs of strain

By Matt Wirz, The Wall Street Journal, Updated May 31, 2023

Lending conditions for companies, consumers and real-estate developers tightened this spring to levels not seen since the height of the Covid pandemic… The slowdown is a consequence of the Federal Reserve’s interest-rate-hiking campaign against inflation, and it means there is now less money available for U.S. businesses and households to hire new workers, build plants and pay the bills…

Recessions over the past 30 years have closely tracked the willingness of banks to lend out the cash they collect from depositors. Bankers are charging higher interest rates on loans to consumers and corporations and for commercial real estate, according to the Fed’s senior loan officer opinion survey. They are also demanding that borrowers post more collateral…

Companies that need borrowed cash to grow, or simply to stay afloat, are running out of options. Corporate bankruptcy filings have hit their highest number since 2010, according to S&P Global Market Intelligence…

The credit squeeze is trickling down to U.S. households. Fintech lenders, mortgage brokers and other nonbank lenders are cutting back credit because they can’t borrow as much and because they see rising delinquencies on the horizon…More households are starting to fall behind on their debt payments… [end quote]

Many “zombie” companies whose cash flow was barely enough to cover interest payments for ultra-low interest borrowing from 2020 are finding themselves unable to pay the higher interest when they try to roll over maturing debts. This forces them into default and potential bankruptcy. This trend will build as more 2020 debt matures as long as the current high interest environment persists.

Commercial real estate has been particularly hard hit due to the trend of at-home work. Most of this market is financed by local banks which are themselves pressured by the Fed’s program. The demand for loans is falling as the cost is rising.

Households are also pressured as their Covid savings are drawn down while loan costs are rising. If a recession begins and unemployment rises, homeowners who can’t afford their mortgages won’t be able to refinance them at a lower mortgage rate since rates have risen.

The job market is still strong so that’s not a large current issue but the government is already proposing assistance. (Not approved yet.)

The economy is not in a recession. Real GDP is growing, though slowly. The job market is still strong. But internal strains are building. This is part of the Fed’s plan. It’s a feature, not a bug in this case.

The risks to investors are clear: recession usually reduces stock values. There’s also a risk that the economy may slow without inflation falling – stagflation.



Inflation is already falling (some of the numbers, especially the “smoothed” ones like housing, can be easily estimated for a few months out). The real issue is if it is falling fast enough, and if it will fall to a low enough level to satisfy the feds requirements (likely somewhere between 2 and 3 percent depending on the severity of a potential recession).