Why "we're not out of the woods" as banks pull back on lending

Driving the news: The recession the U.S. has braced for since late 2022 has yet to rear its head. Barring unforeseen and really dramatic developments, the economy should continue expanding through the third quarter at least.

• The bad news is that the Federal Reserve's tightening campaign is starting to bite, and may even have further to run. As Axios' Courtenay Brown wrote in Monday's edition of Macro, banks are starting to constrict lending (especially in the beleaguered commercial real estate space).

Quick take: Despite visions of a soft landing dancing in the heads of most investors and helping to prop up the stock market, the dwindling availability of credit — combined with higher interest rates — suggests the economy may not be able to defy gravity for much longer.

Zoom in: The possibly worse news is that there's no relief in sight for non-bulge bracket banks that are the lifeblood of U.S. commercial lending.

• In a research note on Monday, Morgan Stanley harked back to Moody's surprise downgrade of a clutch of small and medium-sized banks as a "reminder that the headwinds of increasing capital requirements, higher cost of funding, and rising loan losses continue to challenge the business models of the regional banking sector."

What they're saying: "While the total volume of debt downgraded thus far is relatively small at around $10 billion, Moody's put six banks on review for possible downgrade and changed the outlooks of 11 banks to negative from stable," the bank's analysts wrote.

• "Thus, the volume of bank debt facing the prospect of a downgrade is much higher — well over $100 billion."

What others are saying: At least a few market observers warn the recent run of strong earnings and data — and by extension the market's reaction to it — could be misleading.

• "The word recession has kind of been canceled, but we said a year ago that forces are in place to create a recession. That's still in the cards," Dave Donabedian, chief investment officer of CIBC Private Wealth Management, tells Axios in an interview.
• Better-than-expected earnings, private payrolls and retail sales are inherently backward looking, and "have no predictive value of the future. Recent leading indicators point to a significant weakening in the economy," he adds.
• "Moody's downgrade was a symptom of the problem…for interest rate reasons but also more secular reasons, we're going to go through a rough patch."

The bottom line: Soft landing expectations notwithstanding, "we are not out of the woods yet," warns JPMorgan Chase's Marko Kolanovic in a note.

• "...We see a significant risk that the market narrative could shift again from 'soft landing' towards a 'more extended tightening cycle' which by itself would raise the prospect of a deep and more synchronized recession in 2024, again raising downside risk for risk assets."