8 years of ultra-low interest rates and an avalanche of new financial regulations have driven bank profits off a cliff.
Eight years of ultra-low interest rates and an avalanche of new financial regulations have driven bank profits off a cliff. That’s why the Federal Reserve is raising rates even though the economy is growing slowly. It’s to help banks become profitable again, says Yves Lamoureux, President of Lamoureux & Co.
Banking is supposed to be boring. They borrow money from depositors and lend it at a higher rate. But that began to change in 1979, when Federal Reserve Chairman Paul Volcker allowed banks to start trading U.S. Treasury bonds. Over the next 20 years, the Fed gradually eased restrictions created by the Great Depression-era Glass-Steagall Act such that banks could function as fully-fledged Wall Street broker-dealers. [1]
The key gauge of bank profitability is net interest margin. This tracks the difference between how much a bank pays for money versus how much it gets paid for lending it. This metric peaked in the mid-1990s and has trended down ever since.
There was a spike up in net interest margin in 2009 because of the Fed’s $1.75 trillion quantitative easing initiative, but it was short-lived. Post-crisis banking regulations have made it more difficult for banks to make money with rates this low. And that’s not necessarily a bad thing. The ability of banks to trade with depositor money has been a continual source of controversy over the past 8 years.Nevertheless, the Fed waited an historically long time to begin raising rates again, with the first rate hike coming last December. Typically, the Fed begins its tightening cycle when GDP is above 3%, but the tepid recovery since the Great Recession has not afforded such an opportunity.
With bank profitability near all-time lows, the only way to jumpstart a recover—at least on a nominal basis—is by raising rates, according to Lamoureux. San Francisco Federal Reserve Bank President John Williams recently told Yahoo Finance that he believes short-term rates will be 3.0% to 3.25% within 2 years. That would be concurrent with at least 10 more rate hikes of 25 basis points (0.25%) each.
Whatever the reasons behind the Fed’s decision to raise rates, it will provide many trading opportunities.
Lamoureux believes the U.S. dollar will appreciate 40% from current levels. And he publicly called the bottom in stocks earlier this year in an interview with Yahoo Finance, subsequently cashing out of the position in early May—near the top of the recent rally. Says Lamoureux, “We offer our view now that investors sit back and let bargains come to them. We think we may have a last shake out before a giant melt-up ahead.”
By yahoo
