They lose because they are net monetary creditors. However, they benefit as demand deposit issuers. The second effect may easily outweigh the first with more indexing and more accurate forecasting of future inflation.
Bankers have recently learned to recognize and manage interest rate risk. Bankers learned of the need to hedge their balance sheets against this risk by applying duration analysis, thanks in large part to the efforts of the editor of this journal in a series of articles in American Banker. The duration of equity (a value-weighted average of the durations of assets and liabilities) was set to zero to protect the bank from interest rate risk. With this position, the bank was considered to be immune to modest changes in interest rates. However, this immunization technique only safeguarded the bank’s nominal market value, not its real market value that is, the bank’s market value in today’s dollars, not the bank’s market value in inflation-adjusted dollars. This post aims to start a conversation on how to correct this oversight.
Do banks profit or lose money as a result of inflation? Is it the rate of inflation or the rate of change that matters? Is the impact of pricing changes symmetric? Is it true that disinflation has the same but opposite effects as inflation? What role do expectations play in the process? Is it possible for banks to avoid these consequences?
We’re mostly interested in the impact of shifting prices on net interest income and capital values here. The impact of inflation on noninterest revenue and expenses, as well as the real resource production function of banks, will be discussed in future articles. This latter assumption equates to the plausible (but controversial) belief that actual (inflation-adjusted) noninterest revenue and expense are unrelated to price changes for the purposes of this article.
The focus is on how inflation affects banks, rather than how banks have been affected by specific inflations. As a result, we exclude factors such as increased bank competition and regulatory changes (both of which have a significant impact on bank earnings), as these are not always caused by inflation.
We start by going over the economic literature and the basic “overview” ideas. We then show how both theories are subsets of a broader approach whose major components are rates of change in expectations and portfolio adjustment speeds. The more comprehensive hypothesis serves as a foundation for future research.
In the economics and finance literature, the impact of inflation on actual bank earnings has been extensively explored. There are two competing and opposing models. Banks, according to Alchian and Kessel (A-K), are net monetary creditors (i.e., their nominal assets are greater than nominal liabilities). As a result, rising prices would reduce the value of their nominal assets more than their nominal liabilities. As a result, banks will lose money during an inflationary period.
The inflation tax school, on the other hand, argues that because banks’ demand deposits account for a component of the money supply, they should be able to capture a piece of the inflation tax and so profit during an inflation….
Do banks fare well during periods of high inflation?
Inflation in the United States continues to rise, with the price index for American consumer spending (PCE index), the Fed’s preferred measure of inflation, rising at a rate of 4.2 percent in the year ended July, its highest level in over 30 years. Furthermore, core prices rose 3.6 percent, excluding volatile goods like food and energy. The figures come as a result of rising demand for products and services, which has outpaced supply systems’ ability to keep up following the Covid-19 lockdowns. Although the Fed is optimistic that inflation will fall, noting that it would likely lower its $120 billion in monthly asset purchases this year, the figure is still significantly above the Fed’s target of 2% inflation.
However, we believe that inflation will continue to be slightly higher than historical levels for some years. Personal savings, for example, have increased as a result of the epidemic, and the continuance of low interest rates over the next two years could result in higher prices for goods and services. Companies in the banking, insurance, consumer staples, and energy sectors are among the companies in our Inflation Stocks category that could stay steady or even benefit from high inflation. Compared to the S&P 500, which is up roughly 18% year to date, the theme has returned around 15%. Exxon Mobil has been the best performer in our topic, with a year-to-date gain of 28 percent. Chubb’s stock has also performed well this year, with a gain of roughly 20% thus far. Procter & Gamble, on the other hand, has been the worst performer, with its stock climbing only roughly 4% year to date.
Inflation in the United States surged to its highest level since 2008 in June, as the economy continues to recover from the Covid-19-related lockdowns. According to the Labor Department, the consumer price index increased by 5.4 percent year over year, while the core price index, which excludes food and energy, increased by 4.5 percent. Prices have risen as a result of increased demand for products and services, which has outpaced enterprises’ ability to meet it. Although supply-side bottlenecks should be resolved in the coming quarters, variables such as large stimulus spending, a jump in the US personal savings rate, and a continuance of the low-interest rate environment over the next two years could suggest inflation will remain high in the near future.
So, how should equities investors respond to the current inflationary climate? Companies in the banking, insurance, consumer staples, and energy sectors are among the companies in our Inflation Stocks category that could stay steady or even benefit from high inflation. Year-to-date, the theme has returned nearly 16%, roughly in line with the S&P 500. It has, however, underperformed since the end of 2019, remaining about flat in comparison to the S&P 500, which is up around 35%. Exxon Mobil, the world’s largest oil and gas company, has been the best performer in our topic, with a year-to-date gain of about 43%. Procter & Gamble, on the other hand, has underperformed, with its price holding approximately flat.
Inflation in the United States has been rising as a result of plentiful liquidity, skyrocketing demand following the Covid-19 lockdowns, and supply-side limitations. The Federal Reserve increased its inflation projections for 2021 on Wednesday, forecasting a 3.4 percent increase in personal consumption expenditures – its preferred inflation gauge – this year, a full percentage point more than its March projection of 2.4 percent. The central bank made no adjustments to its ambitious bond-buying program and said interest rates will remain near zero percent through 2023, while signaling two rate hikes.
So, how should stock investors respond to the current inflationary climate and the possibility of increased interest rates? Stocks in the banking, insurance, consumer staples, and energy sectors might stay constant or possibly gain from increasing inflation rates, according to our Inflation Stocks theme. The theme has outpaced the market, with a year-to-date return of almost 17% vs just over 13% for the S&P 500. It has, however, underperformed since the end of 2019, remaining about flat in comparison to the S&P 500, which is up almost 31%. Exxon Mobil, the world’s largest oil and gas company, has been the best performer in our subject, climbing 56 percent year to far. Procter & Gamble, on the other hand, has lagged the market this year, with its shares down approximately 5%.
Inflation has been rising, owing to central banks’ expansionary monetary policies, pent-up demand for commodities following the Coivd-19 lockdowns, company inventory replenishment or build-up, and major supply-side constraints. Now it appears that inflation is here to stay, with the 10-Year Breakeven Inflation rate, which represents predicted inflation rates over the next ten years, hovering around 2.4 percent, its highest level since 2013.
So, how should equities investors respond to the current inflationary climate? Stocks To Play Rising Inflation is a subject that contains stocks that could stay stable or possibly gain from higher inflation rates. The theme has outpaced the market, with a year-to-date return of almost 18% vs just over 12% for the S&P 500. However, it has underperformed since the end of 2019, returning only roughly 1% compared to 30% for the S&P 500. The theme consists primarily of stocks in the banking, insurance, consumer staples, and energy sectors, all of which are expected to gain from greater inflation in the long run. Metals, building materials, and semiconductor manufacturing have been excluded because they performed exceptionally well during the initial reopening but appear to be nearing their peak. Here’s some more information on the stocks and sectors that make up our theme.
Banking Stocks: Banks profit from the net interest spread, which is the difference between the interest rates on deposits and the interest rates on loans they make. Higher inflation now often leads to higher interest rates, which can help banks increase their net interest revenue and earnings. Banks, on the other hand, will benefit from increased credit card spending by customers. Citigroup and U.S. Bank are two banks in our subject that have a stronger exposure to retail banking. Citigroup’s stock is up 26% year to date, while U.S. Bancorp is up 28%.
Insurance stocks: Underwriting surplus cash is often invested to create interest revenue by insurance companies. Inflationary pressures, which result in increased interest rates, can now aid boost their profits. Companies like The Travelers Companies and Chubb, who rely on investment income more than their peers in the insurance industry, should profit. This year, Travelers stock has increased by around 12%, while Chubb has increased by 8%.
Consumer staples: Consumer equities should be able to withstand increasing inflation. Because these enterprises deal with critical products, demand remains consistent, and they can pass on greater costs to customers. Our theme includes tobacco behemoth Altria Group, which is up 21% this year, food and beverage behemoth PepsiCo, which is almost flat, and consumer goods behemoth Procter & Gamble, which is down around 1%.
Oil and Gas: During periods of rising consumer prices, energy equities have performed admirably. While growing economies are good for oil demand and pricing, huge oil corporations have a lot of operating leverage, which allows them to make more money as revenue climbs. Exxon Mobil, which has gained a stunning 43 percent this year, and Chevron, which has risen roughly 23 percent, are two of our theme’s picks.
Heavy equipment manufacturers, electrical systems suppliers, automation solutions providers, and semiconductor fabrication equipment players are among the companies in our Capex Cycle Stocks category that stand to benefit from increased capital investment by businesses and the government.
What if you’d rather have a more well-balanced portfolio? Since the end of 2016, this high-quality portfolio has regularly outperformed the market.
Which industries benefit from inflation?
Inflationary times tend to favor five sectors, according to Hartford Funds strategist Sean Markowicz: utilities, real estate investment trusts, energy, consumer staples, and healthcare.
Do banks fare well during a downturn?
First, during a recession, interest rates tend to fall. Because banks’ principal business model is to lend money and profit, lower interest rates tend to result in reduced earnings. For instance, if a bank’s average vehicle loan interest rate is 5%, it will make significantly more money than if the average rate is 3%, all other circumstances being equal.
Second, and more importantly, during recessions, unemployment tends to rise, and more consumers get into financial difficulty. Consumers sometimes have difficulties paying their bills during recessions, which can result in an increase in loan losses for banks.
The longer answer, though, is that each bank is unique. Consumer banking (accepting deposits and lending money) is very cyclical, particularly for banks that specialize in riskier forms of lending like credit cards. Investment banking, on the other hand, performs even better during stormy times, therefore banks with strong investment banking businesses typically see profits hold up well. Goldman Sachs, for example.
How do banks fare during a downturn?
Even if we don’t fully understand what a recession is, we do know one thing about this dreaded word: it’s terrible news. Unfortunately, our investment rating was reduced to junk status in June 2017, and it was also announced that South Africa was in recession. Still, there’s no reason to be alarmed. Here, we define the term “recession” and show you how to navigate its choppy waters.
A technical recession usually happens when a country’s economic production falls for two (or more) consecutive quarters. There is some good development following the initial downward shift, but it does not sustain. Unfortunately, as reported by The Conversation, South Africa’s gross domestic product (GDP) decreased 0.7 percent in the first quarter of 2017, following a 0.3 percent contraction in the fourth quarter of 2016; a recession was inescapable.
During a recession, the first pattern that develops is that people cut back on their expenditure. People prefer to focus on saving when faced with the uncertainty that comes with a recession.
Unfortunately, most people are unaware that this is their natural reaction, and that it maintains a bad cycle. Less spending implies less consumption, which weakens the economy even more. As a result, the cycle repeats itself. Banks frequently lower interest rates during a recession to encourage borrowing and investing (an attempt to stimulate the economy). As the government strives to foster economic growth through policy changes, taxes and government spending vary as well. However, in the long run, this method may have a detrimental impact on the economy by raising interest rates.
During a recession, it’s vital to be prudent, but conserving everything and refusing to allow yourself modest indulgences like eating out once in a while or buying the clothes you need would only exacerbate the problem. Of course, you should be doing what you should have been doing all along creating and sticking to a budget to avoid overspending. However, there are a few additional options for surviving the storm.
While you may believe you are helping yourself or someone you care about, becoming a cosigner on a loan is not a wise choice, especially in these uncertain times. The truth is that you will be held liable if the borrower defaults on the payments. If it’s your loan, you might not obtain as favorable a rate as you would if you took it out on your own.
Taking on additional debt during a recession is generally not a good decision, with the exception of a home loan, which is used to secure an asset. You should make every effort to pay down your debt as quickly as feasible. Learn to wait and only buy what you require. Things you wish to accomplish should be put off until you have the funds.
While having your mortgage interest rate adjusted to the lower recession interest rates with an adjustable rate mortgage may seem like a smart idea, it’s vital to remember that the minute general interest rates rise, too will your mortgage. Sharp increases in interest rates may damage consumers’ ability to repay mortgage loans to the point that the financial institution has no choice but to reclaim the homes concerned, says Private Property. Its critical to guarantee that you play it safe with a fixed interest rate at times like these.
What are the ways that banks profit from inflation?
- Inflation is defined as an increase in the price of goods and services that results in a decrease in the buying power of money.
- Depending on the conditions, inflation might benefit both borrowers and lenders.
- Prices can be directly affected by the money supply; prices may rise as the money supply rises, assuming no change in economic activity.
- Borrowers gain from inflation because they may repay lenders with money that is worth less than it was when they borrowed it.
- When prices rise as a result of inflation, demand for borrowing rises, resulting in higher interest rates, which benefit lenders.
How do you protect yourself from inflation?
If rising inflation persists, it will almost certainly lead to higher interest rates, therefore investors should think about how to effectively position their portfolios if this happens. Despite huge budget deficits and low interest rates, the economy spent much of the 2010s without high sustained inflation.
If you expect inflation to continue, it may be a good time to borrow, as long as you can avoid being directly exposed to it. What is the explanation for this? You’re effectively repaying your loan with cheaper dollars in the future if you borrow at a fixed interest rate. It gets even better if you use certain types of debt to invest in assets like real estate that are anticipated to appreciate over time.
Here are some of the best inflation hedges you may use to reduce the impact of inflation.
TIPS
TIPS, or Treasury inflation-protected securities, are a good strategy to preserve your government bond investment if inflation is expected to accelerate. TIPS are U.S. government bonds that are indexed to inflation, which means that if inflation rises (or falls), so will the effective interest rate paid on them.
TIPS bonds are issued in maturities of 5, 10, and 30 years and pay interest every six months. They’re considered one of the safest investments in the world because they’re backed by the US federal government (just like other government debt).
Floating-rate bonds
Bonds typically have a fixed payment for the duration of the bond, making them vulnerable to inflation on the broad side. A floating rate bond, on the other hand, can help to reduce this effect by increasing the dividend in response to increases in interest rates induced by rising inflation.
ETFs or mutual funds, which often possess a diverse range of such bonds, are one way to purchase them. You’ll gain some diversity in addition to inflation protection, which means your portfolio may benefit from lower risk.
In a downturn, where should I place my money?
Federal bond funds, municipal bond funds, taxable corporate funds, money market funds, dividend funds, utilities mutual funds, large-cap funds, and hedge funds are among the options to examine.
Is it wise to invest in banks?
- Stocks that trade for less than their true value are sought after by value investors.
- The banking industry distributes dividends, which has a long history and allows investors to participate in earnings.
- Given the leverage and nature of the business, value investors are drawn to bank equities, which are the most vulnerable to emotional short-term influences.
What should I buy before the financial crisis?
Having a strong quantity of food storage is one of the best strategies to protect your household from economic volatility. In Venezuela, prices doubled every 19 days on average. It doesn’t take long for a loaf of bread to become unattainable at that pace of inflation. According to a BBC News report,
“Venezuelans are starving. Eight out of ten people polled in the country’s annual living conditions survey (Encovi 2017) stated they were eating less because they didn’t have enough food at home. Six out of ten people claimed they went to bed hungry because they couldn’t afford to eat.”
Shelf Stable Everyday Foods
When you are unable to purchase at the grocery store as you regularly do, having a supply of short-term shelf stable goods that you use every day will help reduce the impact. This is referred to as short-term food storage because, while these items are shelf-stable, they will not last as long as long-term staples. To successfully protect against hunger, you must have both.
Canned foods, boxed mixtures, prepared entrees, cold cereal, ketchup, and other similar things are suitable for short-term food preservation. Depending on the food, packaging, and storage circumstances, these foods will last anywhere from 1 to 7 years. Here’s where you can learn more about putting together a short-term supply of everyday meals.
Food takes up a lot of room, and finding a place to store it all while yet allowing for proper organization and rotation can be difficult. Check out some of our friends’ suggestions here.
Investing in food storage is a fantastic idea. Consider the case of hyperinflation in Venezuela, where goods prices have doubled every 19 days on average. That means that a case of six #10 cans of rolled oats purchased today for $24 would cost $12,582,912 in a year…amazing, huh? Above all, you’d have that case of rolled oats on hand to feed your family when food is scarce or costs are exorbitant.
Basic Non-Food Staples
Stock up on toilet paper, feminine hygiene products, shampoo, soaps, contact solution, and other items that you use on a daily basis. What kinds of non-food goods do you buy on a regular basis? This article on personal sanitation may provide you with some ideas for products to include on your shopping list.
Medication and First Aid Supplies
Do you have a chronic medical condition that requires you to take prescription medication? You might want to discuss your options with your doctor to see if you can come up with a plan to keep a little extra cash on hand. Most insurance policies will renew after 25 days. Use the 5-day buffer to your advantage and refill as soon as you’re eligible to build up a backup supply. Your doctor may also be ready to provide you with samples to aid in the development of your supply.
What over-the-counter drugs do you take on a regular basis? Make a back-up supply of over-the-counter pain pills, allergy drugs, cold and flu cures, or whatever other medications you think your family might need. It’s also a good idea to keep a supply of vitamin supplements on hand.
Be prepared to treat minor injuries without medical treatment. Maintain a well-stocked first-aid kit with all of the necessary equipment.
Make a point of prioritizing your health. Venezuelans are suffering significantly as a result of a lack of medical treatment. Exercise on a regular basis and eat a healthy diet. Get enough rest, fresh air, and sunlight. Keep up with your medical and dental appointments, as well as the other activities that promote health and resilience.
