Take heed of these four key risks, warns JPMorgan’s Jamie Dimon

Take heed of these four key risks, warns JPMorgan’s Jamie Dimon

Jamie Dimon is chairman and CEO of JPMorgan Chase – the world’s largest bank by market capitalisation – and has been included four times in Time magazine’s list of the world’s 100 most influential people. So his annual letter, released as part of the bank’s latest annual report, is worth reading. In it, Dimon points to four key risks facing all investors. Here is an overview of his letter.

JPMorgan Chase is one of the largest banks in the world with a footprint that covers almost all of the globe, so Mr Dimon has a broad perspective on the state of the global economy, albeit with a US based lens.

Apart from the usual railing against burdensome regulations and capital requirements that create an uneven playing field between global systemically important banks (like JPMorgan Chase), other banks, and the regulatory light approach to Fintechs, he also discusses the state of the global and US economies, current geopolitical changes, and inflationary pressures.

The key message most have focused on is that Mr Dimon expects The Fed to be forced to tighten monetary policy more significantly than the market currently expects, and that long bond rates are also likely to rise more significantly.

The US Economy

The US economy was supported through 2020 and 2021 by US$4.4 trillion of quantitative easing and US$5 trillion of fiscal stimulus. Cumulatively this equates 39 per cent of annual GDP. Of this, US$2.5 trillion ended up in the hands of consumers. This instigated an unprecedented recovery in the unemployment rate driven by strong consumer spending. Consumer spending is currently 12 per cent above pre-COVID levels.

The US economy is in excellent shape with low consumer debt, excess household savings of more than US$2 trillion, strong job demand and wages growth as a result of the stimulus. Essentially, the Government policies have seen potential increases in household debt that would have resulted from the COVID recession transferred to the Government sector. The Government has then monetised this debt by printing money under its Quantitative Easing programme.

But it isn’t all good news. The strength in the economy is not uniform with inflation disproportionately impacting lower-income earners in terms of the real spending power. Low interest rates have fuelled rapidly rising asset prices, benefiting the wealthy as the holders of the capital in the economy, but leaving the less wealthy behind. This has widened the wealth gap.

But the economic landscape is very different to 2008 in the wake of the GFC. In 2008, the consumer and the financial system were overleveraged. Today households have excess savings. Additionally, the quality of the assets that underwrote the debt in the economy was poor due to relaxed lending standards. Underwriting quality has remained good through the COVID period.

Inflation

The flipside to the strong consumer spending resulting from aggressive stimulus has been that with spending on services remaining constrained, the increase in spending focused on goods created severe supply chain issues.

House prices surged during the pandemic fuelled by ultra-low interest rates, with the market remaining extremely undersupplied. The prices of some assets are in bubble territory.
The size of the US labour force has shrunk during COIVD due to 2 million people retiring early, and the supply of immigrant workers falling by 1 million. At the same time, the number of available jobs has increased by 11 million while job seekers fell by 5 million. This has seen wage growth accelerate dramatically, particularly in low-income jobs. While this is good for equality, it causes some disruption for businesses.

Supply chain constraints from disruptions to the production and movement of goods combined with labour shortages has seen inflation rise to 7 per cent in the US. Some of this is seen as transitory due to supply chain shortages, but some is not because higher wages, housing costs, energy costs and commodity prices are expected to persist.

Interest Rates

While the ‘bold’ actions taken by The Fed and US government are viewed as having been the right thing, in hindsight the action was probably too much and lasted too long. The strong economic recovery could necessitate significantly higher rates than the market currently expects.

While the normalisation of monetary policy will be difficult to manage, if The Fed gets it right, Mr Dimon believes there could be many years of economic growth to come. However, in the meantime, as quantitative easing is unwound and interest rates rise, there is likely to be consternation regarding very volatile markets.

The risks of getting it wrong are high because history will not be a guide to manage the process of unwinding the stimulus. Given the difficult task facing The Fed, Mr Dimon believes that it needs to forgo the historical tradition on monthly rate-setting meetings and the pattern of adjusting rate settings by 25 basis points at a time. The Fed will need to be more dynamic in making changes based on data. This would impact the perception of risk in terms of timing around monthly meeting events, but being more reactive would ultimately provide markets with more confidence.

The process of moving from quantitative easing to quantitative tightening will be very different relative to when it was done between 2015 and 2018. Leverage was high heading into the GFC, so quantitative easing helped the economy deleverage. The deleveraging reduced business investment and economic growth, reducing the private sector’s demand for capital. Additionally, regulatory changes forced banks to buy bonds in order to meet new liquidity requirements. This buying replaced the central bank buying to some extent and helped to reduce the upward pressure on bond yields.

This time, the acceleration in growth, supply chain constraints coupled with the need to invest to combat climate change are driving a boom in business investment. Therefore, there is going to be an acceleration in the demand for capital from businesses adding to debt.

Government fiscal deficits are unlikely to be pared materially, so bond issuance will continue at high levels. As The Fed and other central banks pull back from buying bonds, it removes a major source of demand for those bonds. The reduction in demand for bonds as QE winds down and reverses, combined with the rising supply of debt from business investment will shift the supply/demand balance requiring bond yields to rise (ie bond prices to fall) in order to stimulate investor demand and ration it across the higher potential base of debt supply.

The Feb tightening will represent a massive shift in the flow of funds and is certain to have market and economic effects.

Geopolitical Shifts

The effect of geopolitics on the economy are more difficult to predict. The Ukraine War will slow global economic growth due to the sanctions announced to date. The duration of the war and therefore the disruption to energy and other commodity markets could be longer than expected.

But the impacts of the war could impact geopolitics for decades. The invasion has seen democratic countries band together. This has implications for not only Russia but also China. There is likely to be a realignment of alliances around the world and a restructuring of global trade. Supply chains will need to be restructured to ensure countries are not reliant on other countries with different strategic interests for critical goods and services. This will be particularly imperative in the areas of national security.

Mr Dimon advocates for a ‘Marshall Plan’ to ensure energy security for the US and its European allies, which would require the US to secure energy supplies immediately for the next few years and remove Russia’s negotiating power through its supply of oil and gas to Europe.

The degree of change in the geopolitical landscape will depend on whether the west can maintain its current unity.