Atlas Merchant Capital CEO Bob Diamond: Higher rates are good for financial services

Summary

In a discussion about the U.S. economy in 2024, former Barclays CEO Bob Diamond argues that the market may be overly optimistic about the timing of interest rate cuts. He highlights strong economic data, including steady labor markets and resilient equity and debt markets, which suggest the Federal Reserve will be cautious in its approach. Diamond emphasizes that rate cuts are unlikely in the first half of the year, with the second half being more probable. He also notes that the current higher interest rate environment has benefited financial services, with regional and specialist banks presenting promising investment opportunities.

Takeaways

• 😀 The market may be overestimating the number of rate cuts the Federal Reserve will implement in 2024, with expectations running too high.
• 😀 Economic data is strong, with a resilient economy, low unemployment, and stable equity and debt markets, which suggests a possible continuation of the current economic trajectory.
• 😀 A year ago, most economists were predicting a recession, but these fears have not materialized as the economy has stayed strong throughout 2024.
• 😀 The Federal Reserve has not raised rates for six months, with the last increase occurring in July 2023, which has led to speculation about the possibility of rate cuts in 2024.
• 😀 The Federal Reserve is likely to be cautious and patient, with a high bar for making changes to monetary policy, especially concerning rate cuts.
• 😀 The Fed's dot plot, which reflects the views of its governors and presidents, shows that even the most optimistic expectations for rate cuts are focused on the end of 2024, not the first half.
• 😀 While inflation has come down faster than expected, the Fed will continue to prioritize its 2% target, and future decisions will be highly data-dependent.
• 😀 If the Fed remains committed to controlling inflation, restrictive interest rates may push rates higher if no action is taken, further pressuring the economy.
• 😀 The political environment could impact rate decisions, but ideally, monetary policy should remain free of political influence, especially as the election approaches in 2024.
• 😀 High interest rates have been beneficial for financial services, including banks, which are seeing increased earnings due to higher deposit rates and interest rates.
• 😀 The trend of money moving into money market funds has largely run its course, and regional and specialist banks may offer strong investment opportunities in the year ahead.

Q & A

Why does Bob Diamond believe the market might be ahead of itself in terms of rate cuts?

Bob Diamond suggests that the market is anticipating rate cuts too early, especially considering that economic numbers are still strong. He emphasizes that the Federal Reserve (Fed) has not raised rates in six months and that the economy, including labor markets, has remained robust, which makes early rate cuts unlikely.

What is the 'dot plot' from the Federal Reserve, and how does it relate to expectations about rate cuts?

The 'dot plot' is a chart that represents the expectations of Federal Reserve officials regarding future interest rate changes. According to Diamond, even the most optimistic members of the Fed are predicting rate cuts to occur at the end of 2024, not in the first half, signaling a cautious approach from the Fed.

How does inflation play into the Fed's decision-making about interest rates?

Inflation, specifically core PCE inflation tracking close to the Fed's 2% target, is a key factor in the Fed's decision-making. Since inflation has been coming down faster than expected, Diamond notes that the Fed might feel good about their position but will still be cautious in their actions due to the high bar required for initiating rate cuts.

Why does Diamond think it's unlikely that the Fed will cut rates in the first half of 2024?

Diamond argues that while inflation is coming down and the economy remains strong, the Fed has already signaled that it requires strong evidence to change course. The expectation, as indicated by the Fed's dot plot, is that rate cuts will be more probable in the second half of 2024 rather than the first.

How might political considerations influence the Federal Reserve's decisions on rate cuts?

While Diamond hopes that political factors will not influence the Fed's decision-making, there is concern in the market about whether rate cuts could be viewed as politically motivated as the election cycle approaches. However, Diamond stresses that markets generally see through election-related movements and that economic fundamentals should be the primary guide for rate decisions.

What is Diamond's outlook for bank stocks in 2024?

Diamond is optimistic about bank stocks, particularly regional and specialist banks. He notes that higher interest rates are beneficial for financial services, leading to improved earnings for banks. However, he also believes that the move of deposits into money market funds is largely over, and that there will be new opportunities for investment in smaller, specialized banks.

Why were zero interest rates challenging for financial services over the past 12 years?

Zero interest rates were difficult for financial services because they compressed margins, making it harder for banks and other financial institutions to earn profits from lending. For 12 years, low rates resulted in a challenging environment for financial service providers to grow their earnings.

What does Diamond think about the movement of deposits into money market funds?

Diamond believes the large movement of deposits into money market funds, which amounted to $1.5 trillion, has mostly run its course. He expects that this trend will not continue to the same extent, suggesting that the focus for investment in the banking sector will shift to other areas.

What does Diamond mean by a 'high bar' for rate cuts?

Diamond refers to a 'high bar' as the significant threshold the Fed must see in terms of economic indicators—such as inflation and employment data—before deciding to cut interest rates. This bar reflects the Fed's cautious approach to ensure that any rate cut is supported by clear, positive economic signals.

What is the significance of the Federal Reserve's cautious approach in 2024, according to Bob Diamond?

Diamond highlights that the Federal Reserve's cautious approach is crucial because it reflects the desire to avoid making premature moves that could destabilize the economy. With strong economic data and inflation coming down, the Fed aims to maintain balance and ensure that rate cuts, if any, are based on clear and sustained economic improvements.