What is going on with US interest rates?

The US Federal Reserve reduced its interest rate to 0% in an effort to support the economy through the pandemic and beyond. The idea was to kick growth into a higher gear thus rejuvenating the US economy.

However, other problems are now coming into focus, leaving the Fed in a catch-22. Keeping rates low could result in runaway inflation, while pushing them up could cause a financial crisis.

A good way to predict the future is to examine how banks are preparing themselves in the event of a potential hike in rates.

It turns out that some of the major US banks are in disagreement over what is going to happen next based on their respective strategies.

Bank of America boosted its Q3 revenues by earning interest from a debt security portfolio that grew by 77% over the past year, reaching close to $970bn.

On the other hand, JP Morgan kept its deposits at the Fed rather than taking the risk of buying Treasuries or agency securities.

“You’re seeing banks taking various strategies surrounding their balance sheet and interest-rate management,” said Jason Goldberg, bank analyst at Barclays. “Time will tell which is more appropriate than the other.”

Banks are having difficulties allocating the deposits which came in as a result of government stimulus packages and monetary policies which were implemented due to the pandemic.

While the ability to loan money out is favourable, banks have struggled as companies have found other sources of liquidity while consumers have paid off their credit cards and debts.

“If banks are struggling to generate loans, that means they’re going to have to absorb more securities,” said Mark Cabana, head of US rate strategy at BofA. “There is expected to be an ongoing, very strong bank bid for Treasuries.”

However, Treasury prices could well fall, according to Jamie Dimon, CEO of JP Morgan, who says “it’s hard to justify the price of US debt”.

Therefore, it seems that patience is the key word when it comes to decision-making for the major banks.

JP Morgan and Wells Fargo have both suggested that they are willing to wait a little longer, ahead of a possible rise in rates.

“Our view now is that there’s more . . . risk to the upside for rates in the near to medium term, and so we think there’ll be better opportunities to deploy as we look forward,” chief financial officer of Wells Fargo Mike Santomassimo said.

If rates do rise then Treasuries could be shunned by banks. This could be a negative signal for markets in general.

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