Rising behind an exoskeleton of cladding and scaffolding at 270 Park Avenue in New York is what will soon be a towering new HQ for JP Morgan. Excitement within the bank is such that scale models of the 1,388ft skyscraper, complete with ant-like pedestrians milling round its tapered base, have been set up in the foyer of JP Morgan’s current offices around the corner at 383 Madison Avenue.
But in his sitting room on the 41st floor of that older building, Jamie Dimon — executive chairman of America’s biggest lender and unofficial king of Wall Street — had his mind on affairs farther afield when The Sunday Times visited.
Israel’s war with Hamas and Russia’s full-scale invasion of Ukraine have made the world a more “scary and unpredictable” place than at any other time since the Second World War, Dimon contended. “Here in the US, we continue to have a strong economy,” he said. “We still have a lot of fiscal and monetary stimulus in the system. But these geopolitical matters are very serious — arguably the most serious since 1938. What’s happening ... right now is the most important thing for the future of the world — freedom, democracy, food, energy, immigration. We diminish that importance when you say, ‘What’s it going to do to the market?’ Markets will be fine. Markets can deal with stuff. Markets go up and down. Markets fluctuate.”
That said, the conflict in the Middle East — in which at least 1,400 Israelis have been murdered and 9,000 Palestinians killed in Israeli attacks on Gaza since October 7 — has rattled a financial system already gulping at the prospect of inflation proving sticky and interest rates staying higher for longer. The region accounts for 48 per cent of global energy reserves and produced 33 per cent of the world’s oil last year. Previous crises, such as Saddam Hussein’s invasion of Kuwait in 1990 and the Arab oil embargo of 1973-74, resulted in big price shocks — although so far, at about $86 a barrel, oil has roughly returned to its pre-October 7 level, while gas prices have risen only slightly.
There is also the possibility of a more intangible impact on consumers. “When the Russian invasion occurred in Ukraine, we said that the peace dividend is over,” Larry Fink, chief executive of investment giant BlackRock, told The Sunday Times. “Now, with the instability in the Middle East, we’re going to almost a whole new future.
Advertisement
“Geopolitical risk is a major component in shaping all our lives. We are having rising fear throughout the world, and less hope. Rising fear creates a withdrawal from consumption or spending more. So fear creates recessions in the long run — and if we continue to have rising fear, the probability of a European recession grows and the probability of a US recession grows. Geopolitics is playing a bigger role in everyone’s equations.”
The US Federal Reserve’s decision to leave interest rates at 5.25 to 5.5 per cent last week — for the second time in a row after 11 hikes since March last year — was accompanied by balanced language from chairman Jay Powell. He said the central bank was “not confident yet” that it had done enough to be sure that inflation would return to its 2 per cent target, from 3.7 per cent in September — but added that it would proceed “carefully”. This was soothing enough to bring down the yield on ten-year US Treasury bills — an indicator of where the market thinks long-term borrowing costs will sit, and a benchmark used to price assets globally — to less than 4.7 per cent. The yield briefly crossed 5 per cent on several occasions last month, for the first time since 2007, as traders worried that stubborn inflation would force the Fed to hold rates at an elevated level for some time.
Both Dimon and Fink think this could the case. Dimon noted that inflation had “levelled off a little bit” overall, but said: “It’s not clear to me that long-term forces are not inflationary … And that’s why I’m saying rates could possibly go up from here. That’s life in the fast lane.”
Higher borrowing costs have started to hit debt-fuelled sectors that boomed in the zero-rates era — such as commercial property, where $80 billion (£65 billion) of assets across the US are in some form of financial distress, according to MSCI, and private equity. Silicon Valley Bank collapsed in March after the price crash in government bonds, which formed the bedrock of its balance sheet, caused a digital bank run. In May, JP Morgan took over California-based First Republic amid similar concerns over its liquidity.
“There’s an embedded interest-rate exposure in a lot of things,” said Dimon. “These current rates are stressing certain assets, which is mostly manageable for the market. But if they go up another 100 basis points, it will stress even more things — real estate, maybe some banks. That’s why [the legendary investor] Warren Buffett says you see who’s swimming naked when the tide goes out. Not everyone is really ready for 6 or 7 per cent rates, but I wouldn’t rule them out.”
Advertisement
Fink pointed out that the transmission of rate rises into the US economy was less direct than in the UK because most American homeowners take out mortgages with a 30-year fixed rate. But he said: “I’m a fundamental believer that we’re going to have higher inflation for longer, and it’s going to require the [Fed] to raise rates higher — probably one or two more tightenings — and that will ultimately be the way we get into recession.”
Many senior figures on Wall Street worry about the US government’s ability to finance itself in the medium term. As in the UK, the market for government debt was underpinned by huge waves of quantitative easing (QE) after the financial crisis, as the Federal Reserve, in effect, bought assets including Treasuries to boost the economy. Following a revival of the programme during Covid, it came to an end in March last year.
The withdrawal of QE, combined with lacklustre appetite for Treasuries among US banks and international investors such as China, could force the government to pay higher prices at a time of near-record borrowing. The US has issued $1.8 trillion of debt this year, the second-highest amount ever other than in the early stages of Covid. It calmed markets somewhat last week by saying that it would issue longer-dated debt at a slower pace. “It might be a 20km headwind right now, but next year it’s going to be 25km and it’s going to grow,” a top investor said of the decreasing international demand for US government debt.
Amid gathering storm clouds, the biggest banks in the US have reported mixed results. Wells Fargo enjoyed a 61 per cent jump in profits to $5.8 billion in the third quarter, while JP Morgan posted a 35 per cent rise to $13.2 billion. Citigroup was 2 per cent higher at $3.5 billion. Morgan Stanley, which is focused on investment banking and wealth management, suffered a 9 per cent drop to $2.4 billion. Goldman Sachs, which is highly exposed to investment banking and trading, reported a 33 per cent slide to $2.1 billion.
US stock market floats and fundraisings, the heartbeat of capital markets, slumped to their lowest level since 1998 last year as the spike in interest rates punctured valuations of growth stocks in sectors such as tech and healthcare.
Advertisement
Some $152.5 billion of business has been done so far this year, according to data provider Dealogic — a 38.6 per cent improvement on the same point last year. Four big companies went public in September and last month, including chip designer Arm and grocery delivery service Instacart, although the share prices of all four have fallen.
“The biggest impediment to doing business in equity capital markets is volatility,” said Daniel Burton-Morgan, a senior dealmaker at Bank of America. “Markets last year were seriously volatile. This year, excluding the past few weeks, they have been relatively calm.”
The mergers and acquisitions market has been weaker, with transactions down by more than a fifth, although it has received shots in the arm in the form of blockbuster deals struck by oil giants Chevron and ExxonMobil. Goldman and Morgan Stanley, in particular, are in line for big fees from the respective takeovers of Hess and Pioneer.
The cautious mood on Wall Street comes against a backdrop of surprisingly strong US growth. The economy expanded by an astonishing 4.9 per cent in the third quarter, although weaker jobs and manufacturing data last week suggested that it may finally be starting to cool. However hard interest rates bite, the Biden administration is shovelling stimulus into the system via big pieces of legislation promising to accelerate America’s adoption of renewables, rebuild its advanced semiconductor industry and increase its spending on roads, bridges and broadband.
“We have huge stimulus,” said Fink. “People are not factoring in the Inflation Reduction Act, the Chips Act and the Infrastructure Act, which are about $970 billion of stimulus. Those are the largest stimuluses ever when there’s not a pandemic or a financial crisis ... And it’s at a time when you can have unions win a 25 per cent labour increase … These are very inflationary, whether it’s the fiscal stimulus or these wage increases.”
Advertisement
It all comes back to that word. Unexpectedly high growth, massive government stimulus and now two wars that threaten to spill out into broader crises — it all spells inflation. The flurry of hope in markets that Fed and the Bank of England have reached the top of their rate-raising cycles may yet prove premature.
