The US banking sector has been losing ground in 2022 even though the Federal Reserve has hiked interest rates four times since March. In the past six months, the US central bank has increased rates by 200-basis points, but it largely had a negative impact on bank’s share price. Typically, when interest rates rise, that pushes down bond prices and in turn yields rally. The rise in yields helps the banking sector has banks finance their lending capability by borrowing in the short-term, and lending out on the funds in the long-term. In the latest earnings season, JPMorgan, Bank of America, and Citigroup all revealed an increase in net interest margin (NIM), which is profit margin on lending. Bank of America was the standout performer of the bunch as NIM jumped by 22%.
The tightening of monetary policy from the Fed has not only boosted lending margins, it has also sparked volatility in the financial markets, and that has helped equity and bond trading revenue at the big banks. JPMorgan saw a 15% increase in trading revenue at its equities and bond divisions, while Goldmans Sachs confirmed that trading activity in interest rates, currencies and commodities was “significantly higher”. In the three-month period, revenue from fixed income and stock trading was $3.61 billion and $2.86 billion respectively, both topped forecasts. It was a similar situation at Citigroup, as fixed income and equity trading increased by 31% and 8% respectively.
The Fed are hiking interest rates to bring down inflation, which is at 8.3%, and keep in mind, the central bank’s target is 2%. Some of the economic announcements from the US have been mixed recently. As the continuing claims reading hit a five-month high, the services PMI report fell into contraction territory, the weakest reading in two years. Even though the manufacturing PMI report is still growing, it also was the worst reading in two years. The rate hikes are coming at a bad time, so pockets of weakness in the economy so, the raised cost of borrowing is likely to make matters worse.
A common theme from the banks is that they are all bracing themselves for financial pain and that is overshadowing the impressive trading results, and the profitability from lending. Jamie Dimon, the CEO of JPMorgan, warned that an “economic hurricane” is on its way in June. The update was made a few weeks prior to the second quarter report in July, where the bank set aside, $1.1 billion for credit losses. Bank of America declared a credit loss provision of $523 million, and Citigroup warned about a “challenging macro and geopolitical environment”.
In July, the share price of the major banks all fell to multi-month lows, but they have recovered somewhat. It seems that worries about the health of the US economy are biggest influences on the sentiment. The markets are pricing in a extremely probability of another 75-basis points interest rate hike from the Fed this month, and that could spark renewed fears about the direction of the economy.