6 months ago • 1 min
Economic data have been mixed over the past few months, sending conflicting signals as to the strength and direction of the economy. In such an uncertain macro environment, prices have been driven by sentiment, and sentiment by narratives. The problem is: those narratives can change quickly. Just look how quickly we went from gloom-and-doom recession worry to the giddy excitement of hopping onto a big rally. But if sentiment seems sunny now, just remember the economic forecast remains quite foggy. And the main reason is that credit continues to be hard to get.
Credit is the lifeblood of the economy. When it's flowing, companies and consumers tend to splurge, pumping up growth. But when the credit taps run dry, the economy gasps for air, and companies and consumers can struggle to repay the debt they hold. The relationship between the availability of credit for small businesses and defaults among issuers of high-yielding (i.e. riskier) debt is clear: when lending standards suddenly become more strict (light blue line), a big jump in defaults generally isn’t far behind (dark blue line).
What Bank of America calls a “quiet credit crunch” may already be well underway: default rates climbed to 3.1% in May, and 30 large companies have defaulted on their debt in the past five months (compared to 40 over the whole of 2022). And while supportive factors like AI are giving a (justified) boost to sentiment, an increase in default rates may test the bullish narrative and stoke bigger worries about the health of the economy. So, sure, the outlook appears rosier today than it did a few months ago, but it’d be risky to assume that the worst is already over. I’d pay close attention to this quiet credit crunch.
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