Credit growth just fell off a cliff. Company earnings and inflation could follow in 2023.

See, credit growth is a huge driver of economic growth. When new credit is created at a rapid pace, consumers and companies can more easily finance purchases or expansion plans – all of which expands the economy. When credit growth stalls or even shrinks, however, consumption tends to halt, economic growth slows, and inflation eventually weakens.

The chart shows that credit growth in the G5 largest advanced economies (US, Japan, Germany, UK, and France) has dropped sharply this year (black line) as central banks in most of those countries have raised interest rates and as the outlook for the global economy has darkened. Since the economy tends to respond to changes in credit after a lag of 12 to 15 months, that means that a sharp drop in both economic growth and inflation can be expected by the end of 2023.

Now, historical relationships do shift over time. And the way things are now might be different than the way they’ve been in the past. For example, today’s inflation is at least partly driven by supply issues, and today’s consumers are in a stronger financial position than they’ve been at almost any other time. Nonetheless, with credit growth falling so steeply, you shouldn’t rule out the possibility that economic growth and inflation could fall more than investors expect. And while that would be very positive for bonds – which would benefit from both – it’s unlikely to be positive for stocks, which could see their earnings (blue line) hit hard.