Economy
Commercial and industrial loans are leading bank lending higher.
Over the past few months, we’ve held that first-quarter economic weakness was likely due to temporary factors (https://www.aier.org/bcm). We analyzed underlying fundamentals for the consumer sector (April report) and the corporate sector (May report) and concluded that both remained solid. As a result, we expect growth to resume as domestic demand rebounds, despite export weakness amid a slowing global economy and the drag on the domestic energy industry caused by last year’s second-half oil price collapse.
Historically, private-sector credit growth has generally followed economic expansion (Chart 2). In a modern economy with an advanced financial system, borrowers have numerous options for obtaining credit. While U.S. commercial banks have been providing a shrinking share of financing, they remain an integral and important part of credit creation.
Since 2004, the middle of the previous economic growth cycle, U.S. commercial banks have experienced a significant expansion, contraction, and rebound in balance -sheet assets. Key among these are loans (credit) to the various sectors of the economy. Chart 2 illustrates strong growth in lending to commercial and industrial (C&I) borrowers between 2004 and 2008. Commercial real estate loans and the catchall “other” category also experienced significant gains, while residential real estate and consumer loans trailed.
All categories of loans on commercial bank balance sheets contracted during the December 2007 to June 2009 recession and continued contracting into the economic expansion, though none retreated to their 2004 level. C&I loans and “other” loans were the first to start recovering. Both now lead among the loan categories, exceeding prior peaks and about doubling their 2004 levels.
It wasn’t until 2012 that commercial real estate loans and consumer loans began
to recover. But both have risen nicely since and are closing in on prior peaks, with commercial real estate also approaching a 50 percent gain over its 2004 level.
The major laggard continues to be residential real estate loans, which at just 7 percent above the 2004 level have yet to show a sustained recovery. As the economy rebounds, extending loans to more creditworthy customers helps both banks and borrowers and will provide another sign of a return to normalcy in the financial system following the Great Recession.
Economic Outlook
The proportion of AIER’s Business-Cycle Conditions (https://www.aier.org/bcm) leading indicators deemed to be expanding improved to 64 percent in the latest month, following three months at the neutral 50 percent level. Each month, AIER calculates the percentage of its Twelve Leading Indicators that are judged to be cyclically expanding. A reading above 50 percent indicates that continued economic expansion is likely.
Click for interactive Indicators at a Glance (on mobile device turn to landscape)
In our May evaluation, 64 percent of our leading indicators were on an upward trend, marking the 69th consecutive month at or above 50 percent. Consistent readings above the midpoint suggest a low probability of recession over the next six to 12 months. Conversely, a drop below 50 percent indicates an increased chance of a future contraction. However, before drawing conclusions, we look for confirmation from our cyclical score of leaders. For May, it rose to 84 from 79 in April, well above neutral. With gains in our leader’s index and our cyclical score and with both comfortably above neutral, we conclude that the first-quarter economic weakness appears to have been temporary and that the probability of a recession occurring in the next six to 12 months has declined.
The percentage of expanding coincident indicators fell to 83 percent in May, the first decline from a perfect 100 reading in 40 months. While consistent with the first-quarter weakness, we expect to see the coincident indicators return to 100 percent in coming months, following the rebound in the leading index. Among our six coincident indicators, three still managed to hit new cycle highs.
The proportion of lagging indicators judged to be expanding also fell in May, declining to 80 percent from 100 in April and dropping below 100 for just the fourth time in the past 36 months. Yet four of the six indicators reached new cycle highs, while one trended lower and one was indeterminate. Overall, the percentage expanding and the cyclical score for our leading indicators suggest a rebounding economy and declining probability of recession (Chart 3).
