A classic slingshot is Y-framed with two natural rubber strips or tubes attached to the top of the ‘Y’ tethered to a pouch that holds the projectile the shooter is launching. One hand holds the frame, while the other stretches the pocket back far enough to power the projectile to the target. As for its evolution, juveniles first engineered do-it-yourself slingshots forks of tree branches. And while some of these juveniles were delinquents, deploying their self-made munition to carry out vandalism, slingshots also “brought home the bacon” in the form of rabbit, squirrel, quail, pheasant, and dove. The modern slingshot traces to the 1860s, assisted by Goodyear’s introduction of vulcanized rubber two decades earlier. But it wasn’t until 1948 that lucky children unwrapped the Wham-O slingshot. Built with ash wood and flat rubber bands, it had a respectable draw weight of 45 pounds and was suitable for hunting. Who could ask for anything more?
If you’d been in the projectile path of the Treasury yield curve these three trading days, you might have gotten your eye shot out, to blatantly mix historic toy and Christmas Story metaphors. After the 2-year/10-year Treasury spread collapsed to -107 basis points (bps) last Wednesday, the deepest since September 18, 1981, it closed yesterday at 44 bps. Examining daily Treasury yields back to 1962 (using the average of 1-year and 3-year notes as a proxy for the 2-year before June 1976), we’ve just witnessed the third largest steepening in history, a 99.98th percentile event and redefines recession recognition.
Before we go on to illustrate the real-world consequences of what’s transpired, let us be crystal clear and fully on the record in stating this was not capitulation. For all the chatter about Federal Reserve Chair Jerome Powell “breaking something,” this ain’t it…just yet.
That’s not to say we haven’t had credit events already. To name a few, we can tuck into the history books, FTX, UK pensions and the U.S. used vehicle market, a.k.a. American Car Center’s abrupt collapse. Nor do we mean to imply the failure of regional banks won’t ripple across public markets as bank failures should further tighten credit conditions. While the FDIC, Fed and Treasury hope they have staunched the bleed, it would be naïve to presume that we’ve seen the full fallout. There’s no guarantee more banks won’t fail, especially after the debt ceiling is resolved, prompting the refilling of the nation’s checking account balance to its legal minimum.
Getting to our carefully crafted charts, we highlighted an even more ominous inversion in February via the National Association of Credit Management. The credit managers surveyed had noted a disturbing divergence as applications for credit rose amidst falling sales: “Inflation is driving prices higher, which means customers are asking for more credit to cover regular purchases rather than because business is booming. Sales are actually declining now, so the demand for more credit is perhaps out of sync with the business activity it supports.”
Distressingly, and we use that term technically, we’ve just rounded a fifth straight month of inversion in Sales-to-New Credit Applications (light blue line) on the services side. There is a distinct echo in manufacturing as the last of the bottleneck in auto production is resolved (yellow line). Don’t dismiss the factory sector’s tendency to bottom at a deeper inversion vis-à-vis its services counterpart. As for what happens if the extension of trade credit doesn’t cover operating costs alongside a continued weakening in revenues? These inflections are where we see spikes in commercial and industrial (C&I) loans (pink line) as was the case in the 2007-09 recession and 2020’s Covid flash crash.
The regional banking scare is likely to amplify and accelerate the money grab as firms warehouse funding as they would any other resource threatened with scarcity. A shift to large money center banks is also easily foreseeable. Released by the Fed at 4:15 pm ET in its H.8, we’ve added C&I loans to our watchlist.
From the same report, the unprecedented deposit decline at small banks will tack onto our (growing) watchlist of other deposits liabilities (ODL) for small banks. While large U.S. banks are contending with a bigger year-over-year (YoY) downdraft, it’s their smaller peers that have never waged such a battle on the liability side of their balance sheets. Since the series’ 1985 inception, Small Bank ODL has expanded on a YoY basis in every month from 1986 through 2022. That changed in 2023 as January and February saw -0.9% and -1.2% YoY declines, respectively (purple line).
With small banks as key funding providers for Main Street proprietors, the path forward is likely to get bumpier. ADP data forewarn of an already fragile starting point: The smallest concerns that employ between 1-19 workers have recorded job losses in the seven months through February (olive line), while their contemporaries with 20-49 on the payroll are two months into culling their ranks (orange line). The medium and large company spaces have seen continued hiring, bolstering the monthly totals. That said, per Challenger, Gray & Christmas, February’s 23,830 announced hiring intentions are down 87% YoY from the 215,127 in the same month last year. Given lending standards and loan demand had already tightened across the economy before the string of bank failures, and the fear they ignite, it’s a safe bet the broad U.S. economy won’t be able to avoid being sling-shotted.