Rate hikes and reversal of carry trades unlikely to have a domino effect: Jamie Dimon, JPMorgan
- Rate hikes and reversal of carry trades unlikely to have a Domino effect.
- A recession has to be expected but one can hope it will be mild.
- We invest for the long run and through the ups and downs
Have the chances of rates going higher increased?
I think there is a 10% to 15% probability of them hitting 4%, but the future curve embeds a 3% possibility, which may not happen. People have to look at what could increase the probabilities and these are the reversal of QE and greater inflation that people expect. But the important thing is we have good growth, jobs and I don’t think we are building a house of cards.
What does it mean for emerging markets like us?
For every country it is different. India is a $2.5-trillion economy and on the way to becoming a $5-trillion one. If the rupee goes down, it causes issues because you import oil, but India could do fine if rates go up in the US. America growing is good for India as opposed to America having a recession, which will hurt you more than dollar rates going up. India has been growing and some of the new policies with regards to GST and making it easier to do business here are good signs for India.
But some critics say the rupee’s weakness shows that economic management is poor…
That is a mistake. Currencies can go down when the economy is growing. When the rupee goes down, it also means that you are going to export more. Of course, imports also go up so there are pluses and minuses.
It is a natural thing for currencies to move when rates go up. If America grows faster than this country, all things being equal, American rates will go up and the dollar will go up. It does not mean that it is bad for this country. The ‘why’ is far more important than the ‘what’, and people miss that sometimes.
Our banking sector is still state-dominated, with a huge pile of bad loans… We are merging these banks… are we too late?
Reform is hard and all countries have embedded politics and systems. If any country has state-owned banks, it should be very careful about banks being run for political purposes. Credit given out for political purposes almost always goes bad. It is one of the great lessons of history. We all make mistakes but it is important to reform banking systems. If you look at Fannie Mae and Freddie Mac, political pressure made them do a lot of things they should not have done. They happened to be public companies but they had a guarantee from the US government and they used those guarantees to do a lot of irrational things that they thought the government wanted them to do.
It has been four years since this government came to power in India. How do you assess its performance?
You have a very strong and smart prime minister. He is strong enough politically to take the actions that India needs, which is hard to do. If India wants to reach its potential, those actions need to be taken. India is not unique. Even in the US we have things that impact our growth. It takes 12 years to get permission to build a bridge. Countries need to reform those things or they will cause a slowdown in growth. You see it badly in Europe with labour inflexibility.
Laws that were passed with very good intent often achieve the opposite of what they expect. Policy makers need to think very carefully about the benefits and what they want to accomplish and your prime minister has been very good at that.
Why are you positive on India?
Since I have been coming here, we have gone from covering and providing research on 20 companies to over 125. That research is being distributed around the world so we educate the world about Indian companies. We now have close to a 1,000 clients here, which is a mix of multinationals coming in, big domestic firms, global and domestic investors and financial institutions. We work with Indian companies around the world, in China, Brazil, a lot in the UK, and we think that over time, these numbers will continue to grow dramatically.
We were here for an equity conference with 80 companies presenting and more than 200 investors from around the world. We have 34,000 employees here and when I came here first, we had just 5,000. That is also going to go up. Those employees do almost everything for us — buying or selling securities, data security, research and hi-tech programming… They are also open to be hired anywhere in JP Morgan and we have been very happy with all that here. We invest for the long run and will just keep on investing through the ups and downs.
What gives you this confidence?
An educated nation at peace, fixing its problems with strong companies that are growing around the world. It has a population that is growing, political leadership which is strong, with constant reforms and improving. For most countries across history, rule of law, education, and improvement of institutions on a continual basis help them become successful.
You went around the US on a bus trip… What were the takeaways from the trip?
We do road trips all the time to see customers, regulators, governors, mayors, consumers, large corporates. The bus trip is just a unique way of doing it. I wear polo shirts and jeans and we go to branches and call centres and meet tellers and loans officers and we ask them what need to be better, what new systems we need and where should we locate the new branches.
It’s a lot of fun, you learn a lot and it makes you a much better company. In India, we also do the same thing. We go to our Global Service Centre, hold a town hall for our employees and meet a lot of clients.
It has been ten years since Lehman. You sent a note to your staff blaming poor underwriting standards…
There were three roots to the problem. First, Basel II allowed investment banks huge leverage, which they did not have before.
That was a mistake. But the real issue was the poor underwriting that had occurred for years. It only got worse but was masked by the fact that home prices were going up. Government policy encouraged greater home ownership, so people lent more and more money until eventually it blew up. However, the bigger problem was that companies were borrowing unsecured shot-term funding, which means it can be pulled just like that, which resulted in a liquidity shortage. So there were huge failures in the mortgage banks, Fannie Mae and Freddie Mac failed, Bear Stearns failed before Lehman, which subsequently failed mainly as a result of the issues in commercial real estate.
But you pulled back in 2006-07 from some of this….
We avoided some of these problems. We pulled back from subprime, we had virtually no unsecured short term funding, we always had more capital, we were conservative on liquidity. We were well positioned. We did participate in some of the mortgage underwriting, which wasn’t good, but we inherited almost three quarters of the mortgages from Bear Stearns and struggled with that too. We tried to do our job, which was to help finance people in those terrible times.
Asset prices are also at a record high again. Are you doing anything different or holding back on some businesses?
We continue to be very conservative. But we need to be clear; high asset prices are very different from leverage and mortgage.
If you have a stock portfolio and it goes down it does not mean anything. It may lose some of its value but you are not going to panic. But if you had borrowed money to buy that portfolio and then you have to sell those shares because you foresee more selling, that can cause values to drop dramatically and market panic will unravel leverage in the system. The real problem was in the money market funds. Our deposits were going way up because people wanted to leave more money at J.P. Morgan. When the problems in the system began compounding, the government started guaranteeing deposits but once you start guaranteeing deposits, money left healthy institutions to go to government guarantees. So we did a lot of things that made it worse too in the middle of the crisis.
Last time you predicted ten-year treasury at 3% and now you are talking about 5%...
I believe the probability of them going to 4% or 5% is higher than people are expecting. That’s not necessarily bad if the world economy is still healthy. That’s just a return to normalisation. However, if there is higher inflation in the US and the Fed has to raise short-term rates quicker in order to slow the economy down, that’s a different thing. They are also reversing QE, so it could be a lot messier than people are anticipating.
So how do you see this playing out… do you see new fault lines?
Banks today are much safer, there is much more liquidity in the system. The new requirements put in place do make banks stronger and you don’t have the same kind of leverage we had. Things are happening in non-banks… but it is not systemic risk yet. Most underwriting in mortgage is now good; so you don’t have the disease where people are not underwriting. But it’s not like we won’t have a recession one day. A recession has to be expected but your hope it will be mild. Last time we had a panic and people stopped spending money and stopped hiring people and the market slumped and it looked like the great depression.
I can predict that at some point, rates will go up asset prices will go down and credit spreads will widen. I can predict that just like I can predict the sun coming up. I just don’t know when. We may very well have a couple of years of good growth before you see something like that. The global economy is doing okay. Look at India, last quarter its GDP growth rate was 8% plus. China is doing over 6%, America is strengthening, Japan is growing at 1% plus, Europe is 1.5%, unemployment is at an alltime low and we don’t have all those problems we did have embedded in the system.
So what are the problems?
Trade issues will have an indirect effect in terms of sentiment. Then there is the reversal of QE, which is a large number. We have never had QE on this scale before and so we have never had a reversal like this either.
Other central banks will also have to reverse but as long as we have good growth they can normalise rates and we will be fine. However, these are the possibilities that could cause a recession. I wouldn’t say it will happen in 2019 but it may very well happen. There are leveraged entities out there and it will cause certain dollar strength which will impact certain emerging markets. But it is in a completely different regulatory environment. Things like liquidity ratios and certain capital ratios will put some constraints on people’s ability to intermediate. Then there are geopolitical issues.
We have not heard from the WTO…can trade wars escalate. Is global trade coming to an end?
I don’t think it is coming to an end. But I think there needs to be reforms. Global trade has done great for the world, it has lifted 2 billion people out of poverty. The WTO does have some downsides, and there are legitimate complaints that it takes too long, shows favouritism and it does not deal with some of the things the world has to deal with today - like data localization and protection of IP. So it needs to be modernised and hopefully that will happen over time. I don’t think the US will pull out of the WTO.
On trade, we want free and fair trade and there are legitimate complaints about China which the president points out but the method by which you fix them is different for a lot of people. The direct effect is not as bad but it’s the indirect effect and the tit for tat and the chance that the skirmish becomes more than that. It is a high-risk tactic to do it this way. You can sit down with the trading partner and have a conversation on how to fix. That’s true for every trading relationship.
The tariffs could offset certain positives that have been put in place in the US on tax and regulations.
Can rate hikes and reversal of carry trades cause a contagion?
I don’t believe there will be a domino effect like that. There are a lot more reserves in the world today. People have financed more rationally. If we have good growth and dollar rates go higher, people’s borrowing costs will go higher but it has been a cycle and not every country will be the same.