The slope of the curve indicates the return from “maturity transformation”.
When a bank lends money or an investor buys a corporate bond they judge whether they are receiving appropriate compensation to take a liquid cash deposit and lock it up for some period of time.
This maturity transformation is the whole reason modern economies can fund long duration investment, making them prosperous.
The key is the compensation for this risk.
If the curve is very flat, as it is now, then lending to the most creditworthy borrowers makes little sense. Owning their equity makes much more sense.
As well as slowing lending, credit providers will tend to go down the credit curve looking for return. That is, they will be taking more credit risk –behaviour ANZ Research has seen in recent years.
Since early 2011, US banks have eased lending standards in 22 of the 29 quarters – 75 per cent of the time.
Recent data show the proportion of US loans with a rating of single B or below rose from 25 per cent in 2007 to 65 per cent in 2017. The same data show 75 per cent of all 2017 institutional loans were “covenant lite” – very low security - the highest share on record.
Moody’s Covenant Quality Index has been almost continuously below Moody’s minimum protection threshold since 2014.
In this context, the flatter curve may not be indicating much about the risk of a recession in the short term, but it has put a spotlight on lending growth.
Commercial and industrial lending growth in the US has slowed from a peak of 12 per cent in 2015 to a low of 0.5 per cent last year.
This is a puzzle to many, but is entirely consistent with the flattening in the curve over the past few years.