Last week's Fed meeting revealed the high level of uncertainty facing policymakers in the aftermath of the banking crisis, and that recent developments are likely to result in tighter credit conditions for households and businesses and weigh on economic activity, hiring and inflation. Read more.

Measuring the economic impact of the potential tightening of bank lending will take time before it is reflected in economic releases. The Fed's H8 publication (see here) will help us continue to measure the trajectory of bank lending more frequently over the coming weeks.

The risk going forward is that the uncertainty generated by deposit movements will make banks more cautious about lending. This risk is increased by the fact that medium and small banks play a very important role in U.S. bank lending (see charts n°1 to n°4).

The bank lending channel is potentially a major drag on the economic outlook.

• First, an exodus of deposits from these banks could lead to a general contraction of their balance sheets.
• Second, small and medium-sized banks can expect increased regulatory scrutiny in the wake of recent bank failures.
• Third, bankers can reasonably see that the effect of the first two channels will be bad for the economy and will therefore tighten credit standards as they normally do when the outlook deteriorates.

The bank liquidity crisis appears to be moderating, but may be far from over. While the Fed's latest Fed release H4.01 showed a sharp reduction in the pace at which U.S. banks borrowed from the Fed's credit lines (see table below and Chart No. 5), banks appear to continue to lose deposits to money market funds. In fact, Money Market assets grew by a further US$120 bn in the week ending March 22 (see chart n°6) and, as we also commented last week, the latest rate hike by the Fed will probably make it even harder for US banks to compete with the near 5% yield offered by Money Market Funds.(see chart n°7).

Even if a strong systemic shock is contained, tighter credit provisioning by banks is likely to be a further drag on growth in the coming months, and while this disinflationary impulse from the banking system reduces (and potentially reverses) the need for monetary policymakers to slow the economy through rate hikes, there is still a great deal of uncertainty about how large and how much of a disinflationary impulse there will be, there is still much uncertainty about how large and broad the drag on growth will be.

Thus, the level of uncertainty induced by the banking crisis keeps us with a more defensive stance in terms of allocation and we reaffirm our recommendation to overweight fixed income in a balanced portfolio. See more details here.

In particular, in fixed income we are favoring good quality assets, US Treasury, US IG Corporates and more neutral duration (around 4 years).

• Sovereign rates at the short end of the curve have become "quite competitive" with the yield offered by both equities and fixed income.
• Attractive yields, especially in the short term; generally strong balance sheets.

Humberto Mora

Assistant Investment Manager Finance and Business Finance and Business Brokerage Firm