We assume that reflationary efforts will succeed in gradually unfreezing the credit markets. Nevertheless, the need to unwind this decade’s credit excesses means that the economy will continue to face major headwinds to growth, and financial conditions will remain fragile for some time.
Banks will be under pressure to contract balance sheets, even as they sell toxic assets to the Treasury.
There has been a huge overshoot in bank lending in recent years, and a return to trend seems inevitable.
The prospect of an extended period of restraint by both borrowers and lenders raises the issue of whether the Debt Supercycle is over. We are reluctant to conclude it has ended until all policy options have been exhausted. However, it will be a long while before a major new credit upcycle can take hold in the U.S.
There are no leading indicators that will tell us if the bailout plan is working. A cautious investment strategy will be appropriate until there is a sustained narrowing in credit spreads.
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