From my friend Robert Albertson’s crystal ball. No comments from me, because I largely agree with what he is saying. Auctions optimism with emphasis on Cautious…Anat Bird
My outlook for banks and financials in 2025 can be summed up as one of cautious optimism. While the market has expressed premature ebullience over Trump’s election, which definitely included strength in financial stocks, there are many loose and important ends still buried in uncertainties. A sea change in variables is likely to unfold.
Regulatory Relief: Banks and financials will clearly benefit from a shift in tone and substance on the regulatory front. Capital requirements were already in modification indicating lower hurdles than those of the initial Basel III “endgame,” although their final status is yet to be revealed. On the merger front, we can also expect considerable relief and a probable revival of the long-stalled consolidation wave assuming a more bank-friendly posture after new appointments to lead the OCC, FDIC, Federal Reserve and Commerce department, pending confirmations. This is probably the clearest positive for the sector. AB: I strongly agree. Our Forum members expressed a strong consensus earlier last year that a change in the administration is the best way to spell RELIEF. That sentiment resonated sharply after the elections.
Loan Demand: On the macroeconomic front, probable benefits are more unclear based on likely Trump stimulus. The biggest benefit is likely in the commercial borrowing sector. Managements all indicated in their third quarter earnings calls that the hold-up in soft C&I loan demand and moribund corporate spending had been primarily due to election uncertainty as indicated by their business clients. Lower taxation is another positive for commercial demand. This should be another clear positive. Offsetting this has been my longer-term concern for consumer spending, which has been the driving force in overall economic strength to date – a surprise to many economists. However, consumer spending, after definitively outpacing income growth for some time, has gradually decelerated more to the pace of disposable personal income. Moreover, DPI generally follows the combination of job growth and wage growth, which have been slowly ebbing (see exhibit), leading me to conclude some softening here is realistic from the unsustainable level of demand that appeared post-COVID. Additionally, job growth has been outpacing labor force growth for some time, which cannot continue, so it is reasonable to assume job momentum will continue to slow over the coming year.
Interest Rates, Inflation and Net Interest Margins: Here the outlook is more complex. Inflation is still sticky and the level of U.S. Government debt is garnering greater attention. The overall pressure is resulting in higher long-term rates. A 5% or higher 10-year Treasury Rate is increasingly possible. The much-argued short-term neutral rate appears to be certainly above 3% and rising. While the former adds some potential upside to securities portfolio run-off opportunities, the higher resting place for the latter removes some potential upside from the effect of lower funding costs. Net interest margins may hold more benefit in this subsequent rate environment, but it could prove minimal to current expectations. Inflation also appears likely to persist above the Fed’s target, not only for 2025 but perhaps beyond. The prospect for further Fed rate cuts, let alone monetary easing is rapidly dwindling.
Broader Macro Concerns: The likelihood of lower taxes under Trump should prove to be a boon to commercial earnings, but can only exacerbate the Federal deficit, resulting in likely higher interest rates. Higher tariffs on global trade is a distinctly mixed message. While careful imposition of tariffs could successfully be used for bargaining leverage, the risks of an all-out, indiscriminate tariff war going sour are a serious negative for global economic growth and a certainty for higher inflation. Recent news is encouraging, suggesting the Administration is considering application by specific imports rather than universal tariffs by country. It is impossible to forecast the net result at this time, but a higher-for-longer level of interest rates would be damaging to the general economy, especially for real estate.
Broader Global Political Uncertainties: War risk is only broadening, with central Africa capturing a new spotlight while Israel and Ukraine continue to fester. The new Administration supposedly boasts a quick, forced resolution for Ukraine that is likely to be seen as damaging to Europeans and NATO in general. Embers abound for a flight-to-quality period that would be especially damaging to bank loan portfolios tied to the SOFR index, which will fall relative to bank funding costs, starkly unlike the behavior of LIBOR, and few if any bank managements appear to recognize this risk.
In sum there are simply too many political variables, too many governmental unknowns to adequately assess the economic outlook in any helpful detail, until the Trump Administration’s specific policies and legislative options are better revealed. At this time, it is probably going to be April, at the earliest, for key legislation and executive mandates to help solidify the 2025 and beyond outlook. More drama is in store.