Meyrick Chapman is the principal of Hedge Analytics and a former portfolio manager at Elliott Management and bond strategist at UBS.
In Roald Dahl’s James and the Giant Peach, the titular hero embarks on a magical journey. Along the way James meets creatures who control the weather and by the end, (spoiler alert) he has fashioned the hollowed peach pit into a home in upper Manhattan.
Another James has been adopting a far from fantastical tone about the economic weather.
“I said they’re storm clouds, they’re big storm clouds here. It’s a hurricane,” JPMorgan Chase CEO Jamie Dimon warned last week in a conference speech. “That hurricane is right out there down the road coming our way. We just don’t know if it’s a minor one or Superstorm Sandy . . . and you better brace yourself.”
But could Dimon’s apparent concern for economic hurricanes mask a desire to end up with a giant peach?
His concern was divided between the prospects for inflation and the impact of quantitative tightening on market behaviour. High inflation is very damaging for holders of cash, and JPMorgan holds by far the biggest cash balance of the major US banks.
In the form of reserves at the Federal Reserve, JPMorgan Chase held circa $730bn at the end of the first quarter 2022. That’s about 20 per cent of its total assets held in cash. It’s also close to 20 per cent of all system reserves held at the Fed.
With CPI running at close to 9 per cent and interest on reserves at the Fed currently at 0.8 per cent, JPMorgan will be making a substantial real loss, perhaps amounting to $150mn per day. If the Fed raises interest rates quickly, the loss falls, and presumably inflation falls too — marking a double win for JPMorgan.
Of the four largest banks in the US, only JPMorgan persists in maintaining such high cash levels; the reserves held at Bank of America, Wells Fargo, Citigroup are all lower today than they were in mid-2021.
JPMorgan is working to a different end, which Dimon has been outlining publicly for at least a year. In July 2021 he said: “if you look at our balance sheet, we have like $500bn in cash, and we’ve actually been stockpiling more and more cash waiting for [an] opportunity to invest in higher rates . . . I do expect you are going to see higher rates and more inflation today.”
The same theme resurfaced in January this year, when Dimon said in a call with investors that the Fed’s attempts to contain higher inflation may be disruptive. “This whole notion that somehow [the Fed rate cycle is] going to be sweet and gentle and no one is ever going to be surprised, I think it’s a mistake,” he said. “Expect disruption.”
JPMorgan’s nasty real-terms loss on cash holdings may be guiding Dimon’s meteorological metaphors. The more destructive the economic climate, the cheaper assets will become and the sooner the bank will be able to deploy its huge cash reserves at more attractive prices. This puts the bank in a high-risk game of chicken between its near-term cash losses and the expected higher income from Fed rates and future cheaper asset prices.
JPMorgan may not be alone in this approach. Goldman Sachs and Bank of New York Mellon have large reserve holdings. Their negative real returns relative to the size of their balance sheets are as high or (in the case of BoNY Mellon) even higher than at JPMorgan.
But the strategy is by no means common. Most US banks appear to have tried to pre-empt JPMorgan by deploying cash into other assets. Bank reserves at the Fed are down by $900bn from mid December 2021 to end May 2022, with most of the reserves flipped into Treasury bonds or lending to consumers and non-financial corporations. A sizeable chunk has been redirected into “other assets”, which includes all sorts of interesting stuff; you can bet these banks are not looking forward to a hurricane.
The running down of bank holdings at the Fed may offer another gain for JPMorgan. In September 2019, the first sign of tension in liquidity markets from falling reserves caused by QT was in repo rates. To forestall a recurrence the Fed introduced the Standing Repurchase Facility (SRF).
Curiously, the list of approved counterparties for the SRF does not include JPMorgan, although every other large bank is represented. Perhaps its enormous holdings of cash are deemed sufficient buffer against repo disturbance.
The existence of the SRF and the desperation of money-market funds to gain any sort of return has made a blow-up in repo unlikely. Look instead for any signs of strain in the securities settlement process as QT progresses.
If that starts cropping up then JPMorgan would be in a good position. Not just because asset prices would be expected to fall, but because it still holds the largest stock of the medium by which securities transactions are settled between banks — namely Fed reserves.
If that were to happen, it really would be peachy for Dimon.