Brother, can you spare a loan?

Macro Man is writing this before the BOJ announcement, though by the time you read it we'll know the policy choice that was made.  If it's worthy of comment, Macro Man will do so later today.  The elephant in the room of today's session is of course the FOMC announcement; while there is a small cadre of observers that think that the Fed might (or should) hike just to prove that they can to maintain credibility, for once your author takes the opposite view.

To move rates now given the recent activity data would imply a reaction function that is totally random, and Macro Man cannot see how that outcome would do anything but obliterate the remaining credibility that the Fed possesses.  They may well drop a hint that another move is on the cards for December  by saying something like "the Committee anticipates that it will be appropriate to raise the target range for the Federal funds rate in the near future if economic conditions evolve as the Committee expects."

With just shy of a 60% probability priced into December, the FOMC might view such a comment as relatively innocuous, though the bond market might beg to differ...particularly if the BOJ starts selling longer dated JGBs in the open market.  For choice, Macro Man does expect some sort of nod to December, though of course given the recent history of the Fed only a fool would be surprised if they went all dovish again.   Certainly the SEP will permit another round of free easing via lowering the dots...it's the gift that keeps on giving.

Although Macro Man conceded above that a rate hike today would probably not be optimal from a credibility perspective,  regular readers will know that he generally takes the view that rates should be a bit higher to provide savers with a bit of yield, to discourage some of the frothier areas of financial speculation, and to provide non-perverse signals to the real economy about the cost of capital.  Some of the posts written over the past week or so have sketched out some of these views.

One of the obvious rejoinders to the anti-ZIRP/NIRP argument is that modestly higher rates will put a crimp in lending.  Unfortunately, the economy is not a laboratory setting, so we cannot run experiments in a controlled environment to see exactly what will happen under various scenarios.   Econometric models purport to do this, of course, but they remain firmly in the realm of theory rather than empiricism, as their rather sketchy forecasting track record suggests.

One thing we can do, however, is look at current and historical data and try to distill some sort of insights.  While Macro Man has claimed that bank lending has been constrained, perhaps by regulatory issues, on the face of it the data does not really bear this out.  Indeed, the lending totals of US commercial banks has risen nicely over the past several years, putatively spurred by the low level of yields on offer.

But is it really the case that lending is responding to low yields?  The fact isn't totally clear.   What if we look at loans as a percentage of other major commercial bank asset types, such as securities and cash?   If the intent of easy policy is to make it unattractive to hold securities or cash, and instead to incentivize banks to make higher yielding loans, it should show up in the data.

It doesn't.

As of a couple of years ago, loans made up a lower share of commercial bank assets relative to securities and cash than at any point in the 43 year history of the weekly data.  Now, astute observers may say that this is simply a function of QE, given that the Fed created several trillion dollars' worth of reserves, much of which made it onto commercial bank balance sheets.  (Of course, they bought securities from these banks when they created the reserves, so theoretically it should be a scratch.)  It perhaps is not a coincidence that this ratio bottomed when the taper finally ended in late 2014.

What if we strip out cash, and just look at bank loans as a percentage of loans plus securities?   It looks better, but not that much.   The tepid recovery of loans relative to securities in this cycle is notable.   Perhaps not coincidentally, in the last couple of cycles banks only replaced securities with loans when the Fed tightening cycle was well established.    Gee, it's almost like higher rates have incentivized more loans!

Much has been made, of course, of the importance of low real rates in spurring economic activity, presumably through the lending channel.  Macro Man took a look at commercial bank lending and real 10y rates, and guess what?  From 1973 through 2007, there was indeed a negative correlation between changes in real rates and changes in bank lending (-0.37.)  Interestingly, however, since 2010 (i.e., after the recession ended) the correlation has been positive 0.41, implying that higher real rates encourage more lending.

Macro Man wouldn't take these numbers completely at face value; the sample size of the positive correlation period is quite small, for example.   Indeed, over the last couple of years loan growth has been remarkably stable even as real yields have risen and fallen...which ties in with your author's general view that a modest increase in yields should not eviscerate lending, and thus the economy.

Finally, it's worth noting that the large majority of the growth in commercial bank lending has been to businesses rather than households.   This raises the question of what these businesses have been doing with the money- their bond-issuing brethren, of course, have been buying back stock.   It looks like the answer to this question might be "buying commercial real estate."

The obvious follow up is why households are not borrowing more.  The primary answer is that mortgage lending has been tepid...despite the ultra low rates on offer.   Another reason, however, is that really isn't much pent-up demand (except, apparently, for jack-less mobile phones.)  Personal consumption as a percentage of GDP is at record levels, so it's hard to argue that goosing the consumer even further is a viable or even prudent policy.

Putting it all together, Macro Man hasn't seen much to dissuade him of the notion that modestly higher interest rates will not put the kibosh on bank lending.  If anything, the evidence would appear to tilt slightly the other way.  Unfortunately, the ideal window to move has probably come and gone, and as the cycle ages (and borrowing for speculative, rather than capex purposes, continues) the economy and financial system will evolve to become less resilient to changes in rates.

Still, that's no reason to throw your hands in the air and give up, as we'll hopefully see today if and as the Fed lays the groundwork for pulling their finger out.