US stocks continued to rise against the backdrop of the Fed's 2024 interest rate cut signal, but the real world is still under heavy pressure from interest rate hikes.

Over the past two years, the world's major central banks have tried their best to control inflation through interest rate hikes, leading to tight market liquidity. As a result, borrowing costs for governments, businesses, and consumers have risen, and spending will continue to be curtailed for a long time next year. Some studies predict that next year will be the weakest year in the non-economic crisis years since the beginning of this century.

With the peak of debt maturing in the next few years, even if the central bank successfully achieves a soft landing for the economy, the cost of refinancing may still be too high for some companies, which in turn will cause defaults and losses for lenders. However, consumers already feel that the difficulty of obtaining credit is increasing, and regional banks are also facing a huge impact from declining commercial real estate valuations.

The question now is whether the central bank, which has underestimated the threat of inflation before, will take measures to cut interest rates so slowly this time that it has not stopped the economic slowdown in a timely manner.

Earlier this year, US and Eurozone borrowing surveys showed that the credit supply situation is deteriorating, which could reduce the real growth rate of these two regions by 1% to 2% by the end of next year. Economist Stuart Paul expects:

“Interest rate sensitive spending categories will continue to weaken as the impact of monetary policy continues to show.”

It's been a very difficult time for households, whose incomes are being swallowed up by soaring costs of goods and services, as well as higher rent and credit card interest rates.

According to media quoting Nestle CEO Mark Schneider, it is understandable that consumers are facing some difficulties in making ends meet after two years of high inflation. Furthermore, the effects of the central bank's austerity policies are now penetrating the real economy: rising mortgage interest rates and rising rents, all of which combine to make consumers very cautious.

Credit is “harder” to obtain

Data show that currently in the US, interest rates on bank prime loans have risen from 3.25% to around 8.50% recently, more than doubling; this has also affected the recent increase in financing interest rates for Moody's AAA corporate bonds in the US from 2.63% to around 5.67% recently.

Judging from the scale of credit, the scale of commercial loans from US commercial banks has continued to shrink since January of this year, the year-on-year growth rate of consumer loans has declined sharply since October last year, and the year-on-year growth rate of real estate loans has declined sharply since March this year. In addition, the US industrial output index fell 0.6% month-on-month in October, and the manufacturing output index fell 0.7% month-on-month. Supply-side performance has clearly weakened; America's major real estate market indices have also fallen close to this year's low.

Wells Fargo economist Shannon Seery Grein said:

“We have seen that banks have tightened loan standards. This trend is consistent with the period of economic recession in history. Even if the Federal Reserve begins to relax its policies, it will take some time for the overall economy and consumer borrowing costs to feel the effects of easing.”

Businesses are also beginning to feel the pain of uncertain prospects and tight revenues. Toy manufacturer Hasbro plans to lay off 20% of employees due to declining holiday sales. And Ford Motor Company is cutting production targets for its iconic electric vehicles, in part because customers are discouraged from high prices. Moody's downgraded Walgreen Boots Alliance Co. to junk this month, citing factors such as a weak consumer environment.

Bank failure

In 2023, we saw the collapse of Credit Suisse, a globally systemically important bank, while in the US, there was a rush among regional banks. It was only with the intervention of larger banks, governments, and regulators that the crisis was prevented from spreading further.

Furthermore, as commercial real estate loans deteriorate, the development of many small banks will be hampered in the coming years.

According to Trepp Inc., from next year to 2028, the US will have more than $2.8 trillion in commercial real estate debt maturing, most of which will be held by banks. Since its peak, the value of office buildings has fallen 35%, which means banks will face losses of billions of dollars.

Fitch predicts that the US commercial real estate mortgage delinquency rate will soar to 8.1% in 2024 and reach 9.9% in 2025.

The US National Bureau of Economic Research mentioned in a paper this month, “As long as interest rates remain high, the US banking system will face the risk of bankruptcy for a long time.”

Low-rated bond issuers face bankruptcy

After the era of cheap capital ended, the bankruptcy cycle returned, which may engulf some CCC bond issuers, who originally relied on lower interest rates to survive during the pandemic. Although the size of bonds is very small, less than $176 billion, it is still far above the level of soaring bankruptcy during the financial crisis.

Interest spreads between these bonds with a relatively high risk of default and other corporate bonds failed to narrow after Fed Chairman Powell made dovish remarks last week. This shows that bondholders are still cautious about risk.

Oksana Aronov, an analyst at J.P. Morgan Asset Management, said this month that as the credit market as a whole favors low-quality bonds more than ever before, liquidation will come at some point and be accompanied by a dramatic repricing. She said:

“Are there any companies that should not have survived 2020, but have survived because of the support of the Federal Reserve, and now the Fed does not support it.”