AP ImagesJamie Dimon’s annual letter to JP Morgan shareholders is out. It’s loaded with great commentary on the state of banking and the global economy in general.
In one section, he warns about the extraordinary efforts being made by the Federal Reserve to keep interests low to stimulate the economy. Specifically, he’s concerned about the economic damage that could happen should rates suddenly rise. He recalls the ugly experiences of 1994 and 2004.
But having said that, he also notes that JP Morgan is prepared for rising rates.
“As we currently are positioned, if rates went up 300 basis points, our pre-tax profits would increase by approximately $5 billion over a one-year period,” said Dimon. “Remember, however, that all things are not equal, and that $5 billion of improved income should be looked at as an additional cushion to protect us from other bad outcomes.”
Here’s the whole excerpt:
Expansionary global fiscal and monetary policies may create additional potential risky outcomes
Governments around the world, partially but not entirely due to the crisis, generally have been spending more money than they take in. And central banks, mostly as a reaction to the global financial crisis, essentially have been creating money (called Quantitative Easing) to keep rates low and foster a stronger recovery. For the most part, these policies have helped the world economy recover – particularly in the United States. But this medicine is untested, and it may have severe aftereffects. This especially is true if fiscal policy makes it increasingly harder for central banks to slowly remove some of the monetary stimulus. Good fiscal policy and any policies that create growth will make the central banks’ job easier. Higher interest rates and a little bit of inflation won’t matter much if we have strong job growth, good profitability and general prosperity.
We don’t know the outcome of all these efforts. While it is entirely possible that we will manage through the process without too much suffering, there also are some fairly coherent arguments that suggest there could be significant negative consequences. We cannot ignore this possibility and must safeguard against unintended and adverse outcomes. One such scenario would be rapidly raising rates without strong growth. In the recent past, in 1994 and 2004, interest rates, both short term and long term, rose about 300 basis points within approximately a one-year period. In 1994, such action was unexpected, and it caused real damage for many who were unprepared (i.e., the failure of Orange County and significant financial losses at several financial and non-financial institutions). In 2004, the increase in rates was more expected – institutions probably had additional tools at their disposal to manage it, and the damage was far more limited.
Although we are not predicting it, we need to be prepared for rapidly rising rates, potentially even worse than we have seen in recent history. One of the ways we do this is to position our company – if all things are equal – so we can benefit from rapidly rising interest rates. As we currently are positioned, if rates went up 300 basis points, our pre-tax profits would increase by approximately $5 billion over a one-year period. Remember, however, that all things are not equal, and that $5 billion of improved income should be looked at as an additional cushion to protect us from other bad outcomes. You should know that it costs us a significant amount of current income to be positioned this way. But we believe it is better to be safe than sorry.
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