Executives from some of America’s biggest banks will this week tell investors how badly their businesses are being hurt by falling interest rates and an inverted yield curve, setting the scene for a raft of cuts to profit forecasts.
Wall Street’s big six — JPMorgan Chase, Bank of America, Goldman Sachs, Wells Fargo, Citigroup and Morgan Stanley — last gave guidance to investors at their second-quarter earnings in July, when most envisaged short-term interest rate cuts, like the one made by the Federal Reserve in July on the back of a slowing economy.
Since then, further deceleration and fears over President Donald Trump’s trade wars have triggered widespread anticipation of more aggressive cuts, forcing down the rate on longer-term debt.
The 10-year yield on US government debt fell more than 50 basis points and 10-year debt briefly commanded a lower interest rate than two-year borrowings in August — an inverted yield curve that signals an economy in distress.
Wells Fargo analyst Mike Mayo said the deterioration in the 10-year rate — which implies a greater likelihood of recession and therefore a greater likelihood of Fed rate cuts — was far sharper than banks envisaged in July, when many pared back their earnings outlooks.
Industry leaders including JPMorgan chief executive Jamie Dimon, Wells Fargo finance chief John Shrewsberry, Morgan Stanley finance chief Jon Pruzan and Bank of America president Tom Montag will give updates on their outlooks at the Barclays Global Financial Services Conference in New York from Monday to Wednesday.
“The guidance is going to be downward, especially when it comes to the interest rate environment,” said Jeff Harte, an analyst at Sandler O’Neill, who nonetheless thinks the news won’t be as bad as investors fear.
Patrick Kaser, a portfolio manager at Brandywine Investment Management, said a “number of banks, particularly regional banks, will need to cut their outlooks (further)”. “There is no way to avoid cuts, for traditional spread lenders dependent on interest income.”
He sees a possible 3 to 5 per cent reduction in this year’s profit forecasts for the US banking industry as a whole, but believes larger banks that earn more fee revenue will be somewhat insulated.
Falling Fed rates have an almost immediate impact on banks’ interest income, as most loans pay a fixed spread over short-term rates. Declining deposit rates — which save banks money — typically take longer to set in. Mr Mayo said the “big question” was “how much will banks lend at lower interest rates if doing so hurts their margins?”
Lower long-term rates take longer to feed through to banks’ interest margins, but still threaten immediate pain. “It’s already hurting the stocks, we’re already seeing that priced in,” said Mr Harte. “The bigger concern is what that inverted yield curve is signalling . . . historically [it] means a recession is coming, if we have a recession coming that brings a whole bunch of other issues — credit quality, loan growth.”
The majority of large banks’ guidance currently anticipate several more rate cuts by the Fed this year. In July JPMorgan Chase, the largest US bank by assets, forecast as many as two. Falling long rates and an inverted yield curve have a less predictable impact.