Navigating Inflation

Inflation, a curse of developed economies during the 1970s and 1980s, was an economic malady remembered largely by Central Bankers in recent decades as the world’s leading economies basked in a low interest rate environment. This convenient climate for investment shattered in the last eighteen months. Given the current prominence of inflation as a topic of concern this blog post provides a snapshot of this rise in prices, action to reign back inflation and consequences for the banking sector, including JP Morgan. 

According to the World Bank's newest Global Economic Prospects report, global growth is slowing rapidly due to soaring inflation, higher interest rates, less investment and disruption from Russia's invasion of Ukraine. The report also stated that, per-capita income growth in emerging market and developing nations is expected to average 2.8% over the next two years, a full percentage point lower than the 2010-2019 average (Bank, 2023). In developed economies, strong household balance sheets prompted increases in consumer demand just as supply constraints pushed up base prices and political fall-out from the Ukraine war put particular pressure on energy costs. This eased somewhat in 2023 despite the re-opening of China, post-Covid. With higher consumer demand coupled with fewer goods and services available (and higher input costs), price inflation is inevitable.

 

Month on month inflation was extraordinarily high during the first half of 2022. One view was that the underlying push-factors were “once-off” and inflation would fall-back once the system absorbed these, if wage rises could be held in check, and that by 2023 large rises in prices would be no more. The evidence so far in 2023 is mixed. Certainly, energy prices have fallen back but inflation remains stubbornly high in many European economies. In the US, however, the latest inflation numbers are in line with expectations, dropping to 6% year-over-year, with “supercore” inflation increasing slightly (Labor, 2023). There is a view that unless geopolitical circumstances develop adversely, inflation will continue to trend downwards and be more in line with 21^st Century norms. 

 

Actions to Reduce US Inflation

One of the measures taken by the US government to combat the rise in inflation is the impressively sounding Inflation Reduction Act. The 2022 Inflation Reduction Act intends to reduce inflation by cutting the deficit, lowering prescription medicine prices, and investing in domestic energy production while encouraging sustainable energy. Signed into law by Joe Biden in August, the Act combines the “objectives of reducing domestic inflation- notably by the global energy crisis- whilst tackling climate change” (Database, 2023). The $370 billion in investments in the Inflation Reduction Act will lower energy costs for families and small businesses, accelerate private investment in clean energy solutions in every sector of the economy and every corner of the country, strengthen supply chains for everything from critical minerals to efficient electric appliances, and create good-paying jobs and new economic opportunities for workers (HOUSE, 2022). It is argued, however, that the title of the Act is a mis-direction aimed to help sell investment in infrastructure and climate change policies to the US public. While longer-term the impacts on inflation may reflect the Act’s ambitious title in the next few years pump-priming the economy with investment incentives will not combat price rises.

 

More traditional inflation-busting policies are being implemented globally by Central Banks (and the ECB) as they reduce market liquidity and hike interest rates, The US Federal Reserve implemented eight interest rate hikes in a year to February 2023 and at that time gave little indication that it was near to ending it’s cycle. Developments in the last week may, however, lead to a re-assessment - first Silicon Valley Bank collapsed, First Signature Bank wobbled and in Europe one of the world’s leading banks Credit Suisse was rescued via a takeover by Union Bank of Switzerland. The danger for the banking sector is contagion as panic spreads across the sector and more and more banks get into trouble.

 

JP Morgan’s Stance

Inflation is at the top of any investor’s mind which impacts JP Morgan as consumers are feeling the pinch. With inflation showing signs of softening this is matching JP Morgan’s inflation forecast when they set CPI to be at 3.5% in early 2023 compared to 10% in late 2022 (Morgan, January 2023). When the Inflation Reduction Act was approved in August 2022, JP Morgan expressed their views on what the act would do for the US economy. As the Act has undergone a lot of scrutiny, JP Morgan emphasised their view that the Act will be effective but not overnight and at the very least the bill steers the US back towards the Paris Agreement’s aims (Morgan, January 2023). In the EU, there is a concern that they will need to match some of the incentives in the Inflation Reduction Act as there is already evidence of “green” investment leaking from Europe to the US 

 

Why are Banks Wobbly and What About JP Morgan?

Under normal circumstances it might be expected that rising interest rates are good for the bottom line of the banks as the rates they charge many customers rise for loans which the bank secured at historically lower rates. Indeed this proved to be the case in 2022, particularly as the year progressed and rates continued to jump.

 

JPMorgan chairman and CEO Jamie Dimon said, “JP Morgan Chase reported strong results in the fourth quarter as we earned $11.0bn in net income, $34.5bn in revenue and an ROTCE of 20%, while maintaining a fortress balance sheet and making all necessary investments” (International, 2023). So in these circumstances why are banks suddenly wobbling and what are the implications for JP Morgan? Potential problems arise because balance sheets are no longer the “fortress” that Jamie Dimon characterizes. An outcome of the Global Financial Crisis was Banks were required to beef up their balance sheets but rising interest rates have degraded these assets, particularly bonds (whose value is inversely related to interest rates). Thus, as the Fed pushed up interest rates the Securities held by the banks progressively fell in value. So, as in the case of SVB if depositors decide to withdraw their funds the banks sell bonds and realise their losses. While last week the ECB went ahead with another interest rate hike, the Fed have not. In contrast to the signals sent last month that rate hike cycle had not ended, the Fed may now decide to reverse their policy. Maintaining inflation targets is a key Central Bank responsibility but so too is safeguarding monetary and financial stability. 

 

What are the implications for JP Morgan?

Firstly, and most importantly, there is a level of optimism banks will ride out this crisis and contagion will be avoided, although that will always be the “public” line to avoid panic. Secondly, JP Morgan is less vulnerable than many banks, as early as 2021, they switched to a policy of “effectively stockpiling” cash rather than buying Treasury Bonds as they worried higher inflation was a possibility and that the Fed would hike rates (Son, 2021). Finally, as pointed out in an editorial in this week’s Economist “at the largest banks, like JP Morgan or Bank of America, customers are sticky so rising rates tend to boost their earnings, thanks to floating rate loans. By contrast the roughly 4,700 small and mid-sized banks with total assets of $10.5 trn have to pay depositors more to stop them taking out their money” (Economist, 2023). Fingers crossed the optimism of recent days proves well place. 

 

 

Works Cited

Bank, W., 2023. Global Economic Prospectus, Washington: World Bank Group.

Database, I. R. P., 2023. Inflation Reduction Act of 2022, s.l.: IEA.

Economist, 2023. What’s wrong with the banks. Economist, 16 March. 

HOUSE, T. W., 2022. Inflation Reduction Act Guidebook, Washington: THE WHITE HOUSE.

International, P. B., 2023. JP Morgan Chase registers 6% rise in Q4 profit. [Online] 
Available at: https://www.privatebankerinternational.com/news/jpmorgan-chase-net-income/

Labor, U. S. D. o., 2023. Consumer Price Index Summary, s.l.: US Bureau of Labour Statistics.

Morgan, J., January 2023. 2023 Market Outlook: Stocks Set to Fall Near-Term as Economic Growth Slows , s.l.: JP Morgan.

Son, H., 2021. Jamie Dimon says JPMorgan is hoarding cash because ‘very good chance’ inflation is here to stay. CNBC, 14 June.