In a conference on Monday, JPMorgan Chase & Co. (JPM, Financial) CEO Jamie Dimon revealed the largest bank in the U.S. has been “effectively stockpiling” cash instead of using it to buy Treasuries or other short-term investments.
At first, this revelation may seem counterintuitive. Holding off on the traditional stream of short-term, low-return investments will further impact the bank’s net interest income, which is already suffering from low interest rates. Rather than the $55 billion in net interest income that it originally guided for, JPMorgan now expects to bring in approximately $52.5 billion in net interest income in full-year 2021.
The idea is that being patient and hoarding cash will pay off following an expected spike in inflation. Dimon holds that the Federal Reserve would raise interest rates if inflation were to surge dramatically, in which case JPMorgan could swoop in with its cash pile and snap up plenty of higher-yielding assets.
“We have a lot of cash and capability and we’re going to be very patient, because I think you have a very good chance inflation will be more than transitory,” Dimon said. “If you look at our balance sheet, we have $500 billion in cash, we’ve actually been effectively stockpiling more and more cash waiting for opportunities to invest at higher rates. I do expect to see higher rates and more inflation, and we’re prepared for that.”
Back to the basics
In a way, JPMorgan’s decision to save cash for a time when better yields are available ties back to one of the most basic principles of investing: buying low and selling high. In this case, the “buying low” refers to hoarding cash when yields are low, while the “selling high” refers to loaning money out when yields are high.
The “cash is king” stance is another traditional value investing principle that JPMorgan is upholding with this move. Warren Buffett (Trades, Portfolio), for example, has always maintained that “cash is king, especially in times of crisis.” During times of economic turmoil, not only will things be cheaper, the yields on them will typically be higher; this is just as true for bonds and other fixed-income securities as it is for stocks.
A question of ‘when’
Of course, even with a relatively low-risk move like hoarding cash for higher yields, whether or not it will pay off depends on whether things will play out as expected. This will only be the case if higher inflation is sustained beyond what the Fed expects, and if the Fed decides to raise interest rates in response to such a situation.
Later on Monday, Morgan Stanley (MS) CEO James Gorman told CNBC’s Wilfred Frost on "Closing Bell" that he also believes higher inflation will be long-lasting rather than short term, and that the Fed may be forced to hike rates earlier than it hopes.
“The question is when does the Fed move?” Gorman said. “It has to move at some point, and I think the bias is more likely earlier than what the current dots suggest, rather than later.″
However, another problem here is defining what would qualify as “long-lasting” higher inflation. The Fed has thus far been extremely vague on how high inflation would have to spike, and for how long, before it would consider the situation worth taking action over.
The Fed stated in its February meeting that it aims for increased inflation that will result in a “longer run” average of 2%. Inflation has typically averaged below 2% in recent times. Between 2010 and 2020, U.S. dollar inflation averaged below 2% in six years - 2010, 2013, 2014, 2015, 2016 and 2019. As a result, the Federal Open Market Committee is aiming for conditions in which inflation will “moderately exceed 2% for some time” before re-assessing the policy, indicating that inflation will likely exceed 2% in at least six years over the next decade in the FOMC’s ideal scenario.
That’s quite a long period of sustained higher inflation that would be needed before the Fed decides to take action to hike interest rates. Of course, a six to 10-year timeline for 2%-plus inflation would assume numbers that were only slightly above 2%, most likely with none surpassing 3%. The core inflation rate rose 3.8% in May, and if it were to continue at this rate, the timeline might shift to something closer to two to four years instead.
A longer-term view
Given the Fed’s dismissiveness towards hot inflation numbers so far and its insistence that such numbers are only temporary, it seems likely that not even the 5% jump in the consumer price index for May will have much of an effect on policy decisions.
If the core inflation rate were to hit 5% or even remain steady at 3.8%, it wouldn’t take long for the 10-year average to surpass 2%. If core inflation were to average 3.8% for all of 2021, it would result in a 10-year average of 2.34%, and if it were to rise to 5%, the number would be 2.46%. However, both of these averages seem likely to fall within the realm of “moderately” exceeding 2%. If the Fed allows higher inflation in the coming years to “make up for” years of less than 2% inflation over the 2010 to 2020 period, the situation could deteriorate more than investors are prepared for.
In light of the above considerations, it seems that JPMorgan’s cash-hoarding strategy could take at least a couple of years to pay off. For the Fed to consider hiking interest rates, even a 5% increase in core inflation for 2021 might not be enough, unless something happens to change its outlook on whether such numbers will be short term or long term.
