To The Moon

There are two main reasons for the delay in credit tightening compared to monetary tightening in the current economic cycle in the United States.

Firstly, during the pandemic, large-scale fiscal stimulus measures raised expectations for returns in the real economy and financial markets. This kept credit demand strong, despite the increase in financing costs resulting from monetary policy tightening. For example, banks did start to tighten lending standards shortly after interest rate hikes, and the tightening of standards for commercial real estate loans and business loans has risen rapidly to levels similar to early 2020. However, credit growth in terms of scale only began to significantly decline since the end of 2022, and credit spreads have remained low.

Secondly, when the private sector tightens credit, government credit becomes a key variable influencing the economic trajectory. The growth rate of "social finance" in the United States started to decline from the second quarter of the previous year but rose again in the second quarter of this year, primarily due to government financing. Excluding government financing, private sector credit continued to decline, and the growth rate of loans for businesses turned negative. Correspondingly, the proportion of U.S. government debt to GDP rose to 115.5%. In the second quarter, the expansion of government credit offset the contraction of private sector credit, slowing down the transmission of monetary tightening to credit. This was one of the main reasons for the U.S. transitioning from a "soft landing" at the beginning of the year to a "reacceleration" in the third quarter.

So, why did the credit cycle, after contracting, expand again toward the end of the interest rate hike cycle?

1. The Federal Reserve provided liquidity support after the exposure of risk in $SVB Financial Group(SIVBQ)$ to prevent the spread of credit risk.

2. The government leveraged up to support the private sector's balance sheet.

3. Private sector credit continued to decline.

Looking forward, in a presidential election year, government spending is likely to narrow, and high-interest rates continue to contract private credit.

Constraints on spending due to the debt ceiling, political battles in an election year, and rising interest expenses may limit fiscal stimulus in 2024. This suggests that the broad credit cycle, which previously relied on government leveraging, may tighten.

In a presidential election year with the President and Congress divided among different parties, fiscal spending is likely to contract. The credit cycle contracting under the likely scenario of limited fiscal expansion also means that the overall direction of U.S. growth remains downward, unless unexpected financial risks force policy intervention again. This also implies that unless supply factors (such as oil prices and strikes) get out of control, inflation will continue to trend downwards.

However, in the short term, increased bond supply and self-fulfilling trading factors make it difficult to reverse the current trend quickly. To stop the rise in interest rates, we would need significantly weaker economic data than expected, or a risk event creating a flight-to-safety sentiment to reverse this negative spiral. Alternatively, a rapid rise in interest rates that attracts buyers and increases their attractiveness.

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