Cash and money: determinants of bank lending to the non-bank financial sector
0Part 3 of 4
Given the various channels and linkages in global money creation and supply, it is apparent that the actions of a relatively few banks dominate the global credit system and therefore control the availability of credit to the financial system, and this has immense implications for the setting of asset prices on a global and highly correlated basis. It is therefore imperative that we understand what determines the actions of the relatively few banks that lie at the centre of this process.
To expand their lending activities, the global banks will prefer ongoing modest growth in the global economy because inflation and the prospect of rising short and long term interest rates are key risks for these lenders. Indeed it may have been this fear that led to the reduction in credit advances to non-bank financials in late March, which adversely affected T bond prices and which began to affect risk markets as well.
As a connected point, these lenders will wish to see a strong likelihood of further QE, since it is this that ultimately funds their lending activities. However, they will not want to see too much economic weakness since this raises the probability of rating downgrades on the collateral that they have already accepted or might wish to accept in the future. This was a key part of the slowdown in financial sector credit growth that occurred in mid 2009 following the first ‘Greek crisis’. In particular, lenders will not want to see rising perceptions of intra-system counterparty risk since this suggests that their capital positions could notionally be at risk, even in a world that is now highly collateralised and seemingly central-bank underwritten. Rising fears of counterparty risk were clearly very important in the credit and asset market weakness seen in the second half of last year.
The balance between growth, recession and QE is a clear focus for all market participants, and it would seem that global credit conditions and therefore global asset market conditions have become reliant on how a few individuals respond to the particular mix of global news flow that emerges in any given week. Thus some six weeks ago, there seemed to be a belief in stronger global economic growth and therefore a reduced likelihood of QE, which led to credit conditions in the financial sector becoming tighter. However, three weeks ago, softer economic data from the US and elsewhere meant that intra-financial system conditions eased, although they apparently fell back once again as the tone of Europe’s news flow continued to deteriorate.
If over the next few weeks there is a bias towards softer data, coupled with an apparently more pro-QE stance from the Fed, and more erratic behaviour from Europe, markets will likely find it hard to gain a clear direction or trend.
Indeed, we may suspect that markets may begin to range trade as the impact of any good news on Europe or the economy is tempered by the thought that this will reduce the likelihood of QE, while any bad news will raise the probability of QE.
The consequence may be that in the near term, there will likely be some weeks in which Mr Bernanke’s expansionary agenda prevails and others in which Euro and slowdown fears cause the system to shrink. On balance we may expect that markets will exhibit an upward bias, and perhaps the unforecastable risk is in Euroland politics and the upcoming elections.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
