Credit strategists are increasingly disturbed by a sudden and rare contraction of US bank lending, fearing a synchronised slowdown in the US and China this year that could catch euphoric markets badly off guard.

One key measure of US corporate borrowing is falling at the fastest rate since the onset of the Lehman Brothers crisis. Money supply growth in the US has also slowed markedly. These monetary and credit signals  tend to be leading indicators for the real economy.

Data from the US Federal Reserve shows that the $2 trillion market for commercial and industrial loans peaked in December. The sector has weakened abruptly as lenders tighten credit, especially for non-residential property. Over the last three months it has dropped at a rate of 5.4pc on annual basis, a pace of decline not seen since December 2008.

The deterioration in the broader $9 trillion market for loans and leases has been less dramatic but it too is shrinking, falling at a 1.6pc rate on a three-month basis. “Corporate lending has ground to a halt and I am staggered that the Fed is raising rates. They have made a very big mistake,” said Patrick Perret-Green from AdMacro.

Credit experts at several big US banks have issued warnings over recent days, albeit sotto voce. "We’ve been surprised how little attention the slowdown in US bank lending has garnered," said Matt King, global credit strategist at Citigroup.

While they are not yet alarmed, their concerns are worth heeding. Credit has tended to pick up signs of trouble several weeks before equity markets in recent episodes of financial stress.

"Without another big dose of momentum, the cracks in the global reflationary consensus are liable to grow bigger. All around, existing trends are being called into question," he said.

Net corporate bond issuance has also stalled, indicating that borrowing by US firms as a whole is in decline. "So much for a Trump-driven expansion. Beneath the surface, we think a seismic battle is taking place," he said.

Elga Bartsch and Chetan Ahya from Morgan Stanley said the credit squeeze is a warning sign and needs watching closely. “On our estimates, the credit impulse turned negative at the end of 2016. We have not seen such a sharp deceleration in bank lending to US corporates since the Great Financial Crisis,” they said.

“Historically, credit downturns have led recessions. The plunge could reignite concerns that a highly leveraged US corporate sector may react strongly to even limited interest rates increases,” they said.

Monetary tightening in the US so far this cycle has been equal to 13 rate rises under the Fed’s Wu-Xia model, which includes the effects of withdrawing stimulus from quantitative easing. Nobody knows where the pain threshold lies in a global financial system that is more leveraged than at any time in history, including Fed officials themselves.

A study by the International Monetary Fund of 122 recessions in rich economies since 1960 shows that these slumps are typically preceded by a slowdown in credit starting to four to five quarters earlier.

Morgan Stanley said there may be less to worry about this time since the M1 money supply is more or less holding up. This indicator has “reliably contracted” before eight of America’s post-war recessions.

David Fuller's view

How serious is this?  It is certainly a warning, indicating that we are not fully out of the economic trough just yet and into the sunlit fields of sustainable economic recovery. 

The first quarter of the year can be tricky in the US, not least because of cold winters, as we saw last year and also this year, at least until March.  However, the bigger factor this year is still Trump.  Markets were ebullient following his election victory, discounting his economic promises while overlooking the downside of this administration.

Have businesses been more cautious, waiting to see how Trump’s policies affect the US and even the global economy?  I suspect so and talk of trade wars have not engendered the confidence required for long-term investment planning.     

AEP has outlined a worst case scenario, in my opinion.  We should be aware of it although I do not think it is more than a distant prospect.  However, I do think we are heading into a correction, if not now, within 2Q or 3Q. 

Interestingly, I think Trump could bring on a correction very quickly if his economic programmes were either further delayed or seen as floundering.  Wisely, he or at least his advisors are now speeding up their plans for tax cuts, which I would describe as: 1) A corporate tax rate of no more than 25% and preferably lower; 2) Proportional reductions in personal tax rates; 3) A permanent reduction to 10% in the tax rate on repatriated US corporate funds currently held overseas.

If these appeared likely to pass, Wall Street would soar in anticipation of the obvious boost to corporate profits. 

(See also: Trump to Meet With Cohn on Thursday to Discuss Tax Overhaul, Sources Say)

Here is a PDF of AEP’s article.