Deflationary Forces in US and Senior Loan Officer Survey

After the PCE deflator was reported yesterday the Dallas Fed re-jigs it, cutting out strongest and weakest to arrive at a trimmed mean. By its calculations the PCE deflator rose 0.1% at an annualized basis, which is the result of rounding up. On a year-over-year basis the Dallas trimmed mean measure is up 1% vs the 1.3% increase of the core PCE.

A key aspect of the report that few are paying attention to is that of the components, some 44.4% fell in March, down ever so slightly from 45.5 in February. This is quite a large percentage of goods/services experiencing outright price declines from a historical perspective. Although the expansion of the Fed's balance sheet during the crisis, the variant of QE, the large government deficit, many observers are still worried about inflation. The point here is that deflationary forces have not yet been fully defeated.

Also out yesterday, and perhaps overshadowed by other events, the Federal Reserve reported the results of its Q2 senior loan officer survey. While mostly unchanged, there were some signs of loosening after three years of tightening. Bank loans were still contracting, but at a slower pace than recent quarters. Banks eased terms of commercial and industry loans to large and medium sized firms, though there was not net changed in loans to small businesses.

The slowing in the contraction in the demand for bank credit was notable among business borrowers, which may be related to the turn of the inventory cycle from de-stocking to accumulation. The demand for bank loans for residential investment and consumer credit continues to fall and this seems to be a function of de-leveraging and the ongoing stress in the real estate market.

The combination of deflationary pressures and the still poor credit conditions underscores why the FOMC is in no hurry to raise interest rates. Meanwhile, the safe haven demand for US Treasuries appears to be providing some stimulus though lower interest rates that many of even the most seasoned observers would not have expected. Note that year-to-date the US 2-year yield is off 20 bp and the 10-year yield is off 23 bp. Look for the Treasuries refunding announcement on May 5th. Estimates for the new supply is for around $81 bln. The Treasury estimated its Q2 borrowing needs at $340 bln, compared with an estimate of $268 bln 3 months ago. The new estimate includes the bills that the Treasury sells on behalf of the Fed.