Fed rate hikes are good for banks—unless they end in a recession

Interest rates are rising, but bank shares are not.

JPMorgan Chase & Co., Goldman Sachs Group Inc., Bank of America Corp. and Morgan Stanley have fallen this year after two years of big pandemic gains. All four banks are away from their 52-week highs of more than 20%, including a 28% decline in JPMorgan. This can be compared with a 14% decline in the S&P 500.

Higher interest rates are intended to help bank shares, but they have not this year. The Federal Reserve has raised interest rates twice since March in an attempt to curb inflation, indicating that more increases are on the way.

But investors are worried that interest rate hikes that are too large or too rapid could tip the economy into recession. Wider markets and major bank stocks rose on Wednesday after the Fed said it would raise interest rates by half a point. They fell sharply on Thursday and Friday when the reality of a more challenging economic environment set in.

“People are worried that the Fed will push until something breaks, which could lead to a recession and credit losses,” said Citigroup analyst Keith Horowitz, who is mostly bullish on the banking sector and expects all potential credit losses to be manageable.

Higher interest rates could lead to billions of dollars in additional annual revenue for banks as they allow banks to borrow more while paying depositors only modestly more. Banks can also earn more interest on cash that has previously stood still.

Analysts at KBW, a unit within Stifel Financial Corp., estimate that net interest income will increase by 18% at Bank of America and 17% at JPMorgan this year.

Nevertheless, investors analyze various data on the financial health of consumers and companies. The US economy shrank by 1.4% during the first quarter, the worst showing since the start of the pandemic, in the spring of 2020. However, consumer and corporate spending remained strong. Bank managers have pointed to high spending in categories such as travel and entertainment as reasons for optimism.

Market volatility due to higher interest rates and the war in Ukraine has disrupted large banks’ business operations. The market for IPOs has largely been shut down in recent months.

Despite the sales, the bank managers strike a positive tone. “Bank shares have been largely undervalued … in relation to their potential,” Morgan Stanley’s CEO James Gorman said last week / at The Wall Street Journal’s Summit for the CEO Council.

Although Gorman said that a mild recession in the near future would not surprise him, he added that economic uncertainty should not interfere with long-term decision-making. “If you have good strategic things to invest in, whether it’s companies, portfolio managers, investors, you should invest in them.”

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