A slowdown in bank lending is turning into ground zero for adebate over the growing gap between economic hope and reality inthe wake of Donald Trump's U.S. election win.

The deceleration in loans made to companies and consumers hasbefuddled some analysts who worry that the worst growth rate inabout six years bodes ill for the U.S. recovery at a time whenexpectations remain high. With credit acting as the lubricant foreconomic expansion, solving the mystery of the downturn has gainedfresh urgency as investors wait to find out if the enthusiasm tiedto Trump's pro-growth agenda will translate into a tangibleboost.

“One of the stories for optimism at the start of the year wasthat the gain in confidence and financial market deregulation wouldspur a rebound in credit creation,” said Michelle Meyer, aneconomist at Bank of America Corp. “Surprisingly, the data show theopposite.”

Commercial bank credit rose by an annualized 4.2% in the weekending March 15, down from an almost 8% rate last year, accordingto analysis by JPMorgan Chase & Co.

Commercial and industrial loans have seen the biggest slowdown,rising by only $67 billion over the past 12 months, compared with$191 billion over the course of 2016 in a sharp reversal of amulti-year trend that has seen such lending surge to a record $2.1trillion of outstanding loans.

Ask bank managers what the problem is and you'll get a lot oftheories: Regulators have been eyeing underwriting standards in thewake of the lending boom, a shortage of qualified workers ispreventing businesses from expanding, the rout in oil pricesstymied demand, bank loans have been competing with a booming bondmarket, and of course, interest rates have been rising. But high upon the expansive list is the simple idea that it takes time for amore cheerful mood to materialize in actual activity.

“I would tell you that there is a huge amount of optimism out inthe marketplace and I believe that it's going to be translatinginto a substantially higher loan growth as we head through theyear,” said Kelly King, CEO of BB&T, in response to analystqueries.

The lending cooldown contrasts with surveys taking the pulse ofthe U.S. economy. Figures released Tuesday showed consumerconfidence jumping to its highest level in more than 16 years,fueling questions over the growing gap between “hard” and “soft”economic data that has opened up since November.

“There have been a few troubling signs recently, particularlyaround loan growth that is consistent with this idea that businessmay be waiting for policy change and in the near term we couldactually hit an air pocket in the U.S. economy where businesses areon the sidelines, and we get a period of slower growth,” said PaulEitelman, strategist at Russell Investments, adding that executivesneed to see the Trump administration deliver on its policy promisesbefore they can ramp up investment.

Corporate credit analysts at UBS Group share that concern,blaming a potent mix of political uncertainty, rising rates andhistorically high corporate borrowings for reduced demand forcompany loans. Companies have taken advantage of years of lowinterest rates and yield-hungry investors to load up on debt in awide variety of forms.

“Anecdotes abound today that high leverage is altering realeconomic decisions. Companies today want to be sure that growth andtax policy will be tailwinds, before committing capital to work,”wrote analysts led by Stephen Caprio. “Simply put, the buffer for amiscalculation is not there for levered firms.”

Josh Rosner, bank analyst at Graham Fisher & Co., worriesthat the dip in lending may herald the long-awaited turn of thecredit cycle after years of growth. He notes that more loans onbank balance sheets have been souring this year, which may spurbanks to try to off-load nonperformers to specialist funds andinvestors.

“It appears that with rates low, banks have been able torefinance loans of weaker credits to support performance,” he wrotein a note published Wednesday. “Having scraped the bottom ofthe borrower-quality barrel it is likely that as rates rise, orliquidity is reduced, delinquencies and defaults will begin to riseas fewer credits will be able to be rolled.”

Others are far more sanguine. While slowdowns in bank lending dotend to coincide with recessions, there have been some instances ofit softening in the midst of an economic expansion, according toeconomists led by Jan Hatzius at Goldman Sachs Group and DanielSilver at JPMorgan.

The downturn in commercial and industrial bank loans isa “classic 'rear-view mirror' indicator of slowing economicconditions from late 2015 and early 2016, and as such doesn'tprovide any insights into future economic conditions,” said ChrisWatling, chief strategist at Longview Economics, an independentresearch firm.

What's more, expectations of future credit conditions arebullish, presaging a likely uptick in corporate demand for loans inthe coming months, according to Longview. Only a net 3% of U.S.businesses expect credit conditions to deteriorate, for example,according to a February survey from the National Federation forIndependent Business. That's the strongest expression of confidenceon credit conditions since 2004 — businesses are routinely negativeon the credit outlook — and compares with a long-term average of7.2%.

Whatever the cause of the slowdown, investors won't have to waitlong to find out if it's a temporary blip or something moreprofound. A model by Bloomberg macro strategist Cameron Crise thatsmoothes changes in sentiment surveys suggests the drop in lendingis reaching its nadir.

At Bank of America, Meyer sees a three-quarter lag betweenimproving consumer confidence and credit growth based on historiccorrelations, which would mark early 2018 as the market's moment oftruth.

“This means the potential improvement in the economy, asindicated by the strong surveys, is more a story for the next yearthan this year,” she said.

Bloomberg News

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