I have always argued that the Fed will move their publicly announced stance on raising monetary policy. The many events of the last one month have moved the public perception of a 30% hike in March to 90% now. The market was discounting three 0.25% hikes for the year while Goldman Sachs has stated that it could be four. But Jamie Dimon the CEO of JPM who has become an industry spokesperson for the banking sector thinks there can be six to seven hikes for the year.
What all this does for the Fed is it makes their job easier in case they decide to raise rates higher than what they have communicated. Volatility in the markets is based on public perception. If the surprise element is taken out or reduced markets will be less volatile. While the Fed has a dual mandate of controlling inflation and managing the employment rate, their biggest concern or fear is to avoid a big fall out in the stock market. If you go to see the lion's share of their emergency actions have been mostly to support the equity markets.
In 2020, with the Covid situation, the Fed decided to take all credit risk and flooded the country with excessive money and cut interest rates to zero. The biggest beneficiaries of this action were growth companies and banks.
While growth companies, especially the ones with no profits and cash flows will struggle to keep their stock price momentum up in a rising interest rate environment banks should continue to do extremely well.
Firstly, even before the pandemic banks have been pushing profits into reserves to cushion themselves for any crisis situations. All the major four US banks reported on Q4 earnings this week and they have beaten the street estimates. All are buying back their stocks. For the full year 2021, Wells Fargo made $21.5 bio, Citi $ 22 bio, Goldman $21.6 bio and JPM $48 bio. All net income.
In a crisis, the banks win as policymakers intervene to backstop risk. In a recovery, the banks win as well, as strong consumer and balance sheets lead to hotter demand for bank products. Add to that, rising interest rates help banks to benefit more profits with wider lending spreads. With a broader market P/E of 29, the banking P/E’s are a steal. Citi is the cheapest at 6.6.
During the last year, supply chain disruption and inflation were the biggest talking points. This year will be more about labour costs and inflation. With the latest inflation reading of 7% and the Fed funds at zero, the Fed is way behind the curve. The longer this gap persists, the more difficult the Fed will make it for themselves. Compound to that, oil prices have been going through the roof. It has broken above a 7 year high and has risen 62% over the last 12 months. The Fed likes to pretend that they are not concerned about the volatility in oil as they never mention oil in their public statements. The truth is they always act when oil prices go haywire whether it is up or down.
With all this, a few industry pundits are calling for a Fed hike in Mar by 50 basis points. Hedge fund manager Bill Ackman is one of them. A 50 basis point hike in one shot will surely rattle the markets. Markets are already reacting to this by taking the 10-year yields above the last two year highs.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund. Currently, he is setting up a hedge fund where foreign citizens can invest in Indian growth stocks like Tanla operating in hyper-growth markets like CPaaS.