Updated: Sep 5, 2022
On June 1st, at the annual Strategic Decisions Conference held in New York City, Jamie Dimon (CEO of JP Morgan) warned investors of an "economic hurricane," predicting the inability of the Federal Reserve to execute its quantitative tightening program without triggering “unintended consequences.” “You’d better brace yourself,” Dimon told the roomful of analysts and investors. “Right now, it’s kind of sunny, things are doing fine, everyone thinks the Fed can handle this. That hurricane is right out there, down the road, coming our way.” Six weeks later, JP Morgan released their Q2 earnings report, missing street estimates for the first time since early 2020. The headlines were grim: 30% fall in profits, net investment banking fees falling 55% and mortgage originations down 45%. The negative sentiment was reflected by analysts and television anchors, with CNBC host Jim Cramer left “very worried” and Oppenheimer, Credit Suisse and UBS all re-rating the stock and cutting fair value estimates. So, the question is, has the hurricane arrived?
The short answer… probably not. The fall in profit was expected, with the bank setting aside some $428 million for a precautionary "rainy day fund". Consumer spending remained high, reassuring investors, despite the fall in fees collected. And, largely unmentioned by the media, JP Morgan’s trading fees rose 15%, with the company taking advantage of current market volatility. "We have looked very carefully into our actual data," said Jeremy Barnum, JP Morgan's CFO, "There is essentially no evidence of actual weakness."
So, whilst the Q2 report at JP Morgan was not as damaging as first thought, strong concerns remain over the future of the world economy with Jamie Dimon on July 14th reinstating his view on an upcoming recession. "Quantitative tightening will reduce liquidity in global markets and stock prices will go down a lot." A report by Oxford Economics agrees, “Just as extreme excess liquidity helped push valuations up during the pandemic recovery, so will its withdrawal punish the markets. It may well be that the markets are underestimating how much valuations will decline – and, indeed, our quantitative analysis suggests just that. Should the central banks not refrain from substantial balance-sheet normalisation, more painful stock market corrections may lie ahead.” The “extreme excess liquidity” pumped into the economy through quantitative easing programs is shown in the graph below. The balance sheet of the Federal
Reserve has more than doubled between March 2020 and July 2022, from $4.3 to $8.9 trillion. Critics of QE argued that these programs would lead to hyperinflation and create monetary instability (which ironically defeats the entire purpose of having a central bank).
The critical question for the world economy is what happens to the cost of credit. Governments, households and the private sector are all more leveraged today than ever in modern history.
Since interest rates peaked and began falling in the early 80s, credit has replaced savings as the driver of economic growth. So, when credit growth was strong economic growth was strong. When credit growth weakens, as has been the case recently, economic growth falls too. As is quite likely, if interest rates are hiked as a result of QT, private sector credit growth, which is already slowing, will slow further. This may be compounded by a negative wealth effect if asset prices move lower too. So, perhaps it will take a few more quarters for Jamie Dimon’s hurricane to materialise, but storm clouds are already fast approaching.
Edited and Reviewed by Tanish Bagga.
References/ Further Reading