More bets on a Fed March rate cut as US bank earnings a mixed bag

As we move towards the end of the week there are a few things that are worth pointing out. Firstly, the market has increased expectations that the Fed will cut interest rate by 25 basis points in March, secondly, US bank earnings were a mixed bag, and thirdly, the Vix remains stubbornly low.

The third point is important in our view. We know that the Vix doesn’t stay low forever, yet it doesn’t appear to be rattled by recent geopolitical issues or concerns from some that the market is too optimistic about Fed rate cuts. The Vix is currently trading around the 12.5 level, which is suggestive of a bull market, yet financial markets have appeared directionless so far this year. Something doesn’t fit with the Vix at this low level. Usually that only happens when the outlook for stocks is bright, but after rallying strongly at the end of 2023, there is a lot of divergence of thought about where US stocks will go next. Hence why this is a strange time for the Vix to remain calm.

The other big mover this week has been the Fed Funds market. After the weaker than expected producer price data from the US, there is now a 74.2% of a 25bp rate cut from the Fed when they meet on March 20^th. This is up from a 70% chance on Thursday and significantly higher than the 39% chance of a rate cut 1-month ago. The market is defying calls from Cleveland Fed President Loreta Mester, who is a voting member of the FOMC until she retires in June, that March is probably too early for a rate cut. She is a notable hawk, but her comments this week suggest that a Fed rate cut in March is not clear and the decision could be on a knife edge unless we start to see more signs of economic weakness between now and then, which is certainly possible. The FOMC does not like to surprise the markets, if they think that they will not hike rates in March, then expect a wave of hawkish Fed speak in the coming weeks. Whether or not this moves the dial for the Fed Funds market, we shall have to see.

US bank earnings were a mixed bag. JP Morgan was by far and away the star performer. It reported record profits thanks to rising net interest income, with annual profit of nearly $40bn. Net interest income rose to nearly $90bn, which is higher than the bank had predicted last year. They also said that the effects of higher net interest income would be positive for 2024. Although EPS figures missed analyst estimates, the share price rose at the US open on Friday, as investors focused on the good news and the big numbers included in this earnings report. This is yet another example of how JP Morgan has become larger and more profitable after a financial crisis. It did the same after 2008, and now it looks like a winner after the regional banking crisis last spring, even though it took a $3bn charge in relation to the crisis.

For other banks, the earnings season was not so rosy. Citigroup had its worst quarter in 15 years in Q4, and it reported a loss of $1.8bn for the quarter. The bank also announced 20,000 layoffs. Although a bright spot was investment banking fees, which rose after a tough few years. Wells Fargo missed analyst estimates and Bank of America reported a larger than expected loan loss provision of more than $1bn, as the US consumer shows small signs of stress in some credit markets. The market reaction to the earnings is fairly subdued. The financial sector in the S&P 500 is up slightly, while both Citigroup and JPM are higher by approx. 1%. This suggests that the market is willing to show leniency for Citigroup if it is on the road to recovery, and it will also cheer JPM for its good news on net interest income in the coming months, but upside for JPM could be limited if the market is right and the Fed starts cutting rates in March.