The Fed asks banks about credit conditions for firms and consumers, and the latest Senior Loan Officer Survey shows that banks are starting to tighten lending standards on commercial and industrial loans.
This is what the Fed wants to see because the goal for the FOMC is to slow down hiring and capex spending and, ultimately, inflation.
The challenge for the Fed is that the ongoing tightening in lending standards has not yet resulted in a corresponding widening in high yield spreads, see chart below.
The Fed’s goal is to tighten financial conditions and credit conditions, and if credit spreads don’t widen out further, then the Fed will have to do more with rates. Financial conditions are not tightening as much as the Fed would like to see, and as a result, the Fed will have to do more of the work by raising short-term interest rates further. Because the Fed is fully committed to getting inflation down from the current level at 8.5% to the Fed’s 2% inflation target.
For markets the conclusion is straightforward: The Fed wants to tighten financial conditions and investors should be positioned accordingly.
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