Each quarter, the Fed also gives a summary of both the mechanics and the reasons for the shift in lending standards. Banks last year were easing standards primarily via reduced spreads and they did so because of increased competition (from banks and nonbank lenders) and a more favourable economic outlook. The shift to unchanged standards in the latest quarter, though, reflects a more uncertain economic outlook as the main reason.
If, since the Fed last surveyed the banks in Q4, growth has continued to slow and the curve to flatten, there seems to be a reasonable prospect the next reading on lending standards will show further tightening.
In fact, in the Q3 2018 SLOS, banks were asked an ad-hoc question on how their lending policies would potentially change in response to a hypothetical moderate inversion of the yield curve prevailing over the next year.
“Significant shares of banks indicated that they would tighten their standards or price terms across every major loan category if the yield curve were to invert,” the SLOS report found.
The bottom line is that, if the curve continues to surprise us and flattens further or even just stays around zero, the Fed may well need to become more responsive to the economy.
If the Fed doesn’t act, the risk is that it may walk the economy into the recession that didn’t need to happen.
Richard Yetsenga is Chief Economist at ANZ