How falling interest rates impact the US financial sector | Charts that Count

How falling interest rates impact the US financial sector | Charts that Count


Today I’m going to talk about
the impact of falling interest
rates on the financial
part of the US economy.

If you can remember
as far back as 2018,
in the middle of that year
there was resurgent optimism
both about the US economy
and the idea that perhaps
after a multi-decade
decline in bond yields,
interest rates were
finally going to rise.
But at the end of that
year all of that optimism
came to an end.
Danger signals from the world
economy and world markets
caused a decline in
the 10-year yield,
and with it the
economic prospects
of companies in the financial
sector took a nosedive.
So here in November 2018
is when the 10-year yield,
after several months of
rising began to fall again,
and predictably financial
stocks, four of which
are represented here,
started to fall.
Since then, however,
as bond yields
have continued to fall and have
settled at very low levels,
different companies
in the finance area
have responded in
very different ways.
Now the basic reason
you might worry,
if you are in the business
of holding, moving,
or lending money,
lower rates means
lower revenue and lower profit.
Not all companies
suffer, however.
Visa stands to profit
simply when money moves.
It’s not exposed to
the price of money.
And after an initial
decline, when
anxieties about the economy
were at their highest,
the company has continued
its long bull run.
So where do you want
to be in financials
when rates are falling?
You want to be in
a company that’s
not exposed and
just profits from
the ever-increasing velocity
of money through our economy.
You don’t necessarily want
to be an investor in a bank.
The red line
represents JPMorgan,
which is the biggest and
most diverse of the US banks.
Yes, JPMorgan is exposed
to falling interest rates.
It’s core business
is still lending,
but they have investment
banking, credit cards, mortgage
lending, all of these businesses
which give their portfolio
greater diversity.
They have big advantages of
scale, and despite lower rates
JPMorgan’s stock has
held up pretty well.
And if you looked at shares
of the other large US banks,
you would see a similar pattern.
Small US banks have
not been so lucky.
Comerica is a much smaller bank,
very exposed to core business
lending, which is the most
interest sensitive of all banks
businesses.
And it has simply been hammered
by declining interest rates.
Banks like this, so-called
asset sensitive banks,
depend on interest rates
for their core business
and have been hammered
by the stock market.
And there is an open
question about how well
smaller rate sensitive
banks can compete
with the giant diversified
banks such as JPMorgan.
The blue line may be
the most interesting.
Why would an online broker
stock behave like a bank?
Because E-Trade makes its
money by collecting interest
on the deposits
of the people who
trade on its broking platform.
E-trade stock behaves
just like Comerica stock
up until early October.
Here, when the company
got some bad news,
not from the right markets but
from one of its competitors,
Charles Schwab, who cut
trading commissions to 0,
forcing E-Trade to do the same.
So suddenly, not only
was E-Trade suffering
from the impact of
lower interest rates,
but its competitive situation
was getting markedly worse.
So its non-interest revenue
was going to decline.
So what this chart
as a whole shows
is that while the financial
sector is rate dependent, how
different parts of the
financial economy respond
can be very different.
These stock prices are a good
proxy for that diversity.
Companies all across
the financial sector
are under acute pressure from
falling and low interest rates.
But what the experience
of E-Trade shows
us is that interest rates are
not the only source of pressure
that’s out there.
Whether you are a pure
payments company like Visa,
an asset sensitive
bank like Comerica,
a big diversified
bank like JPMorgan,
or an online brokerage
like E-Trade,
you also depend on fee income.
And fee income in
an environment where
the economy is under
pressure and competition
is intense is also in danger.

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