March 21, 2025 | In the this issue of The Institutional Risk Analyst, we look at the latest press conference by the Federal Open Market Committee and comment on what this means for banks and financials in 2025. Even as President Donald Trump demands rate cuts, the Powell FOMC is sharply reducing US economic growth estimates and increasing explicit inflation concerns, meaning that banks and other cyclical firms will reduce internal growth estimates accordingly.
On a positive note, the Fed is slowing the reduction of the system open market account (SOMA), meaning that bank deposits may start to grow in Q2 2025. Fed Chairman Jerome Powell said in a somewhat cosmic but remarkably indefinite response to the last question of the press conference from Jean Yung of MNI Market News:
JEAN YUNG. Well, I guess my question is more, was [slowing QT] meant to be a temporary measure during the debt ceiling episode, or?
CHAIR POWELL. You know, it was -- it was actually the TGA flows, Treasury General Account flows that got us thinking about this, but the more we thought about it, we came around to this. And you know, it is, yes it was provoked, the original discussion was provoked by that. But I think what we came up with though, was broader than that and different and it does address that issue but it really is also, it fits in really nicely with our principles and our plans, and the things we've done before, and the things we said we would do.
It amazes us how so many monetary economists miss the significance of the changes in the Fed's balance sheet given 1) the size of the public debt and 2) the necessary expansion of the SOMA to keep pace with the federal debt. Perhaps when the Fed’s balance sheet exceeds the total assets of the US banking industry later in the decade US monetary economists will get the joke. Talk to our friends in Mexico and Argentina. They remember hyperinflation with tears.
Source: FDIC
The message coming from the top banks is cautious as Q1 2025 ends, although Bank of America (BAC) CEO Brian Moynihan went against the bearish narrative rising on Wall Street and said that the bank is tracking 6% spending growth compared to the same period last year. But is BAC financing that growth? Below we discuss the positive and negative factors affecting financials.
The biggest negative factor for banks is the lack of visibility on the economy. There were a number of important comments in the press conference this week by Fed Chairman Powell, but the key point for banks and all financials is that the level of uncertainty about the direction of the economy is so high that the Fed is essentially prepared to go in either direction. To us this was perhaps the post important comment by Powell:
“I'm confident that we're well-positioned in the sense that we're well positioned to move in the direction we'll need to move. I mean, I don't know anyone who has a lot of confidence in their forecast. I mean the point is, we are -- we are at, you know, we're at a place where we can cut, or we can hold, what is a clearly a restrictive stance, of policy. And that's what I mean. I mean I think we're -- that's well-positioned. Forecasting right now, it's you know, forecasting is always very, very hard, and in the current situation, I just think it's uncertainty is remarkably high.”
Or to put it in the poplar lexicon: "We have no idea." The lack of clarity on the economy is a function of the Fed and the machinations of the Trump Administration in Washington. The changes that are occurring across the government are substantial and disruptive, but nowhere more than in housing.
President Trump has gutted the FHA and Ginnie Mae, and most recently the Federal Housing Finance Agency. We expect to see headcount reductions at both GSEs and a shrinkage of the footprint away from anything but purchase mortgages. A reduction in the conforming loan limit may come before much longer. At a minimum, the layoffs and headcount reductions by President Trump will reduce the flow of credit to all US housing markets.
While we support the general idea of reforming the government housing complex, we worry that the speed and arbitrary nature of some of the Trump policy changes may tend to increase the surge in credit expenses that is already visible. As we’ve noted in recent profiles and the most recent edition of The IRA Bank Book, credit expenses in areas such as commercial and multifamily real estate are already high, but net losses on consumer lines such as autos and credit cards are also rising.
When you take the lack of visibility on the economy and an expectation of slower growth, to us that means that our readers should assume a recession or at least a serious slowdown is approaching. Add to this the already pronounced tendency of banks not to foreclose on commercial assets and instead forbear on non-performing loans. Then we finally note that there is $100 billion worth of income accrued but not collected by banks – more than a quarter’s worth of earnings – another indicator of credit distress we noted in the Bank Book.
Source: FDIC
If you add all of this up, we have an uncertain view of the economy and an increasing certainty of higher credit expenses in the future. To us, the increased uncertainty in the minds of Americans and the tight labor markets is not a combination that leads to economic expansion and could easily slip into recession. Again, Fed Chairman Powell said this in the press conference:
“You have pretty high participation, accounting for aging, you've got wages that are consistent with 2 percent inflation, assuming that we're going to keep getting, you know, relatively high productivity. We've got unemployment, you know, pretty close to its natural level, but job, the hiring rate is quite low. But so is the layoff rate. So, you look at initial claims or layoffs, so you're not seeing people losing their jobs, but you're seeing that people who don't have a job having to wait longer and longer. And you know, the question is which way does that break? If we were to see a meaningful increase in layoffs, then that would probably translate fairly quickly into unemployment because people are, you know, it's not a -- it's not a big hiring market. We've been watching that, and it's just not in the data, it hasn't happened. What we've had is a low firing, low hiring situation, and it seems to be in balance now, for you know, for the last six, seven, eight months.”
In the next issue of The Institutional Risk Analyst, we review the Q4 results for the top seven depositories, with a particular view on credit and growth in Q1 2025. If credit expenses are to rise in 2025, then the industry needs to find a way to push up loan growth and asset returns. In Q4, the average return on assets for Peer Group 1 was still sub 1% after years of financial repression by the Fed. Does market volatility create an entry point for investors or a signal for investors to head for the lifeboats?
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