Stronger Loan Demand: Where are the Higher Rates?

U.S. banks are continuing to see loan growth improve, both for businesses and consumers, as the economy has strengthened considerably. However, interest rates have been more influenced by international flows.

Solid U.S. Economic Fundamentals Drive Loan Demand

Loan growth at commercial banks has continued to trend upward as the U.S. economy is currently experiencing the strongest rate of economic growth in a decade. Propelling loan growth forward over the past two years has consistently been commercial & industrial (C&I) lending, which expanded 13.2 percent in December. Consumer lending has been less impressive during this expansion, however, it has begun to pick up meaningfully in recent months, growing at the fastest pace since June 2009 in December (excluding the accounting rule change in 2010, top chart)

There are a multitude of factors that seem to be playing a role in improved loan growth and money supply growth. The Fed balance sheet has remained around $4.3 trillion as the Fed continues to reinvest the proceeds from maturing assets. As a result, the M2 money stock continues to grow at near a 6.0 percent pace, almost perfectly in line with the average for the previous expansion. Consumers’ balance sheets have also improved with household net worth now more than $13 trillion higher than its prerecession peak and household debt as a percent of disposable income down from nearly 125 percent at the beginning of the downturn, to 96.6 percent today. Improvement in the labor market and growing consumer confidence have helped to fuel growth in consumer spending, which individuals now feel more comfortable financing with loans, once again. On the supply side, banks are also gradually loosening standards. All these factors result in greater demand for loans, in theory, should put upward pressure on interest rates. So what is keeping long-term rates in check?