Why bank stocks are sinking with rising interest rates

M.UCH is higher Milk prices are generally good news for dairy farmers, high interest rates are good news for bankers. Conventional lenders make their money based on the difference between the interest they pay on depositors and the interest they earn on loans and investments. That gap widens as the rate increases. And as interest rates are set by central banks that tend to rise only when the economy is strong – when jobs are plentiful, spending is high and inflation is high – rising rates also usually mean that borrowers will be well-placed to repay their loans.

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Expectations for Treasury yields and interest rates in the U.S. have been high since mid-December, when the Federal Reserve announced it would accelerate its plan to reduce its asset purchases. On January 18, ten-year Treasury yields rose 1.9%, the highest level in two years. As recently as October, investors expected the Fed to raise interest rates by only one unit in 2022. But they quickly revised expectations as consumer price inflation rose, rising to between four and five a year.

So when the six largest banks in America — Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo য়ের reported earnings for the last quarter of 2021 between January 14 and 19, their executives gladly directed higher interest income. Asa JPMorgan’s boss Jamie Damon thought that market expectations of an interest rate hike could be even more conservative. “My view is that there is a very good chance that there will be more than four,” he said in an earnings call on Jan. 14. “It could be six or seven.”

Yet, surprisingly, lenders’ share prices have fallen (see chart). Shares of JPMorgan have fallen nearly 12% since the bank reported earnings. Goldman’s shares fell 7% in a single day on January 18, after it released its earnings. What is the solution to this seemingly paradox?

The first possible explanation is the cost, and in particular the climbing of the wage bill. In 2021, Goldman’s compensation costs increased 33% year-over-year to $ 17.7 billion, an increase of $ 4.4 billion. City’s wage bill rose 33% in the fourth quarter, compared to a year earlier, and compensation costs rose 14% at JPMorgan and 10% at Bank of America over the same period.

Partly higher wage costs reflect rising business: Goldman’s profits for 2021 were higher than their previous all-time high of 60%. But costly compensation raises growing concerns about how inflation has taken root in the United States. “There is real wage inflation everywhere in the economy,” David Solomon, Goldman’s boss, told investors in the bank’s earnings call.

An alternative explanation for the fall in stock prices is that investors fear that higher rates are not unequivocally good news for US banks. The flood of cheap money pumped into the financial markets by the Fed in 2020 and 2021 has helped push asset prices to new heights. Goldman earned $ 22 billion from the business in 2021, the highest since 2008.

Easy Money has contributed a delicious fuel to the company-financing activity. Speed ​​of Deal Making and Initial Public Offering (IPOs) has been almost confusing. Worldwide IPOs raised a huge amount of capital in 21 600bn in 2021, compared to about $ 200bn in 2019. Trading and corporate finance together have created tremendous profits for Wall Street firms. In 2021, global investment-banking revenue was $ 129bn, up 40% from the previous year, according to data provider Dealogic.

But now, as inflation rises and monetary policy changes, banks’ bumper profit margins could end in mid-2020. Looking at the last three months of 2021, it is clear that the recession has already begun. Trading earnings at JPMorgan fell 11% compared to the same period a year earlier (although revenue in 2019 was still above their level of 6%).

Considering that bank officials have been warning for months that trading and dealing revenue will eventually return to pre-epidemic levels, their impending normalization may not come as a surprise to investors. The fact that the share price has fallen, then, could indicate a hidden fear. The advent of extraordinary stimulus triggered an unusual period of profitability for bankers. Perhaps the punters are concerned that the removal of such stimuli may prove unusually frustrating. 3

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This article appeared in the print edition of the section “Finance and Economics” under the heading “Mixed Message”

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