Investors are hoping that financials will benefit from rising interest rates. But it is a complicated calculation. If the Fed seriously considers aggressively tightening monetary policy, it could backfire on the big banks.
The Fed should no longer raise its rates gradually. The consensus view among economists is that a series of quarter-point hikes will no longer suffice.
The Fed is behind the inflation curve. It’s time for shock and awe.
After cutting rates to zero at the start of the pandemic in March 2020, the Fed held rates there until they were finally raised to a range of 0.25% to 0.5% in March.
But, according to futures trading on the Chicago Mercantile Exchange, investors are now pricing in nearly an 80% chance of a half-point hike at the May Fed meeting and about a 55% chance of another half-point increase in June. There is even more than a 30% chance of a three-quarter point rate hike, within a range of 1.5% to 1.75%.
Larger rate hikes could eat into corporate earnings and lead to even greater stock market volatility. Bank earnings could also be hit, as a drop in Wall Street
could potentially lead to lower demand for mergers and further stock sales. The Wall Street giants are reaping lucrative advisory fees from deals, initial public offerings and special purpose acquisition company (SPAC) listings.
The Training Effect of Higher Rates
An economic slowdown caused by significantly higher rates
could also hurt demand for mortgages and other consumer loans.
Mortgage rates are now approaching 5% and could continue to rise with longer-term Treasuries. The 10-year Treasury yield hit around 2.7% this week, the highest level since March 2019.
Thus, any increase in profit margins on loans could be offset by a decline in lending activity. People would be less likely to buy new homes in a real estate market that has already become prohibitively expensive for many Americans.
The inversion of the yield curve could also hurt banks. With rates for shorter-term bonds – notably the 2-year Treasury – briefly rising above 10-year Treasury rates, it could also limit profits for banks that have to pay higher short-term rates on deposits. .
“The recent curve inversion has been an overhang for bank stocks, with uncertainties around earnings growth and credit,” KBW chief executive Christopher McGratty said in an earnings preview report for the first quarter. trimester. He specifically cited “the risk of high filing costs.”
It also doesn’t help that an inverted yield curve tends to be a fairly reliable predictor of a possible recession. Needless to say, the banks would not do well if the economy were to pull back sharply.
All of these concerns are hurting bank stocks. Investors seem more worried about a possible pullback than excited about the potential near-term increase in loan earnings.
Two exchange-traded funds that hold shares of most major banks, the Financial Sector Select SPDR (XLF) and SPDR S&P Regional Bank (KRE) ETFs are both down this year, as is the overall market.
“Rising inflation and rising interest rates could lead to a recession in the United States. The course of the pandemic could also alter consumer behavior as we continue to move towards a new normal,” he said. said CFRA bank analyst Kenneth Leon in an earnings overview report.
“U.S. households could be more frugal and conservative in using their credit cards or consumer loans. Uncertainties remain over the outlook for consumer and commercial lending activity as well as investment banking,” he added.
Inflation could get worse before it gets better
Soaring prices remain a major problem for many consumers. The US government will make this painfully clear once again next week when it releases two key inflation
reports in March.
The consumer price index will be released on Tuesday morning. Economists predict CPI figures will show prices are up 8.3% over the past 12 months, according to Refinitiv. That would be up from February’s year-over-year increase of 7.9%, which was already a 40-year high.
And experts aren’t predicting much relief on the horizon just yet.
Inflation problems are likely to get worse before prices start to fall. Stifel’s chief equity strategist, Barry Bannister, forecast in a recent report that the annualized increase in the CPI would reach 9% in the coming months, before finally starting to ease in the third quarter.
Inflation is even more of a problem at the wholesale level. The government’s producer price index, which measures the prices of raw materials sold to businesses, jumped 10% in the 12 months to February.
The fact that the PPI is rising even more sharply than the CPI could be a sign that companies are unable or unwilling to pass on all of their higher costs to consumers. This could hurt profit margins in the future.
Monday: inflation in China; UK manufacturing production
Tuesday: consumer prices in the United States; income from CarMax (KMX) and Albertson
Wednesday: producer prices in the United States; revenues from JPMorgan Chase, Delta (DAL)BlackRock and Bed bath and beyond (BBBY)
Thusday: ECB decision on interest rates; US weekly jobless claims: US retail sales; US Consumer Sentiment (U. of Michigan); income from Taiwan semiconductor (TSM), UnitedHealth (A H), Ericsson (ERIC)Citigroup, Wells Fargo, Morgan Stanley, Goldman Sachs, Ritual Aid (GDR)US Bancorp, PNC, State Street and Ally Financial
Friday: Major stock and bond markets around the world closed for Good Friday