June 27, 2022 | For many readers of The Institutional Risk Analyst, the past few months have been a bundle of contradictions, with interest rates rising at the start of Q2 2022 and now falling as the quarter concludes. Note the widening gap between the 10-year Treasury note and 30-year residential mortgage rates.
With this in mind, we come back to JPMorgan (JPM), one of our favorite large banks but one that is never particularly cheap because of the bank’s massive institutional following. The Q1 results were probably the best for this year and featured numerous cautionary statements from CEO Jamie Dimon.
The big question for the money center banks, which as a group tend to be at most 50% core deposits, is about how the eventual imposition of quantitative tightening or QT will effect bank deposits. At $19.9 trillion as of Q1 2022, US bank deposits are about $3-4 trillion above normal levels. Steven Chuback of Wolfe Research asked the key question during the JPM analyst call:
“In the past, you've spoke about the linkage between Fed balance sheet reduction and deposit outflow expectation for yourselves and the industry. And with the Fed just outlining a more aggressive glide path for balance sheet reduction, how should we be thinking about deposit outflow risk?”
CFO Jeremy Barnum proceeded to answer the question in a thoughtful but overlong fashion. He noted that “industry-wide loan growth outlook is quite robust and that should be a tailwind for system-wide deposit growth.” He then continued:
“Then you just have to look at what's going to happen in the front end of the curve particularly in bills. So the Treasury has to make decisions about weighted average maturity and what makes sense there. There's obviously a little bit of shortage, of short-dated collateral in the market right now. So, that might argue for wanting more supply there. The Fed has to make decisions about portfolio management. They talked in the minutes about using bill maturities to fill in gaps and so on and so forth. And so those things are going to interact in various ways.”
Dimon, who warned shareholders earlier this year that the market is underestimating the number of Fed hikes that might be needed to curb inflation, then clarified the issue of QT and bank deposit runoff.
“So the answer is we don't know, okay. And you guys should read economists' reports, but the fact is initially it probably won't come out of deposits. Over time, it will come out of wholesale and then maybe consumer. We're prepared for that. It doesn't actually mean that much to us in the short run. And the beta effectively, we don't expect to be different from what it was in the past. There are a lot of pluses and minuses. You can argue a whole bunch of different ways, but the fact is it won't be that much different, at least the first 100 basis point increase.”
So now here we are at the end of June and JPM and the rest of the industry have already seen a 100bp move in market rates, but the Fed has still not clarified its intentions with respect to the SOMA portfolio. So if you are Jamie Dimon or the head of any of the major banks, you are not exactly getting clear guidance from Fed Chairman Jay Powell and the FOMC.
Dimon advises that liquidity will drain from the system starting with wholesale balances, but this is hardly glad tidings from the biggest repo counterparty in the market. Since the Fed has not yet been able to convince most banks to utilize the standing repo facility, JPM remains a significant chokepoint in the institutional market for funds. And, in fact, deposit growth in the US banking system is already starting to slow, as shown in the chart below.
While total deposits in the US banking system continued to grow in Q1 2022, the rate of increase was the lowest in several years. More important, Q1 2022 is probably the peak in US bank deposits for this cycle, suggesting that the runoff described by Jamie Dimon may be occurring sooner and more rapidly than was anticipated in early April of 2022.
We anticipate that over the course of the next year, total bank deposits could shrink by several trillion dollars as the Fed’s balance sheet begins to run off. As the chart above suggests, a "normal" level for US bank deposits would be closer to $15-16 trillion than $19.9 trillion today. And as the FOMC begins the process of shrinking the balance sheet, look for growing volatility in the funding markets.