Dimon, Debt And Impossible Math

Jamie Dimon was in the news on Tuesday for the not-exactly-groundbreaking observation that Fed funds at 7% could be disruptive.

“Going from 0% to 2% was almost no increase. Going from 0% to 5% caught some people off guard, but no one would’ve taken 5% out of the realm of possibility,” he told The Times of India while in Mumbai for a JPMorgan conference. “I’m not sure if the world is prepared for 7%.”

With respect, I’m not sure that’s newsworthy. Also, there were at least some people who “would’ve taken 5% out of the realm of possibility.” Take a look at the dot plot from the March 2022 FOMC meeting: There wasn’t a single Fed official who projected a terminal rate anywhere near 5%.

So, if Dimon is looking for individuals who thought 5% was out of the question, he needn’t look any further than the people who actually set that rate.

But what do they know, right? Nothing, as it turns out, which, ironically in this context, is why some people are inclined to fade the idea of a “higher-for-longer” Fed funds. That’s the mantra for a group of people who, in December of 2021, projected rates would be around 1.6% right now.

Anyway, Dimon is right to suggest the world might not be “prepared” for 7% rates. “I ask people in business, ‘are you prepared for something like 7%?’ The worst case is 7% with stagflation,” he went on, during the same interview. “If they are going to have lower volumes and higher rates, there will be stress in the system. We urge our clients to be prepared for that kind of stress.”

Then he quoted Warren Buffett’s naked swimming folk wisdom on the way to warning that the hypothetical 200bps from 5% to 7% would be akin to the tide going out. “These 200bps will be more painful than the 3% to 5%,” Dimon addded.

He should know. JPMorgan had to help bail out the system in March when, on the 15th anniversary of the Bear Stearns deal, a run on concentrated deposits forced SVB to realize losses on bonds it wouldn’t have otherwise sold. The ripple effects destabilized First Republic, which Dimon eventually bought.

Of course, that episode woke banks up to the uncomfortable prospect of unrealized losses on “riskless” assets becoming actual losses, and the Fed’s BTFP ostensibly mitigates the inherent risks. But it’s not all about the banks. As Dimon alluded to, 7% rates would reverberate. America’s $1 trillion-plus credit card debt load would be unserviceable, personal loans would come with extraordinarily onerous rates, auto loans too, and somewhere between the run up to 7% and the inevitable recession that’d ensue, mortgage rates would probably approach 10%, before a deflationary crash pulled down long-end US yields.

As more than a few observers dryly pointed out in recent months, the idea that rates can go higher and stay higher in a world where total debt now stands at $307 trillion, according to the Institute of International Finance, is debatable.

As the IIF wrote earlier this month, “the sudden rise in inflation” catalyzed a rather dramatic decline in the global debt-to-GDP ratio starting in Q2 2021, when “many sovereigns and corporates inflate[d] away their local currency” debt alongside red-hot growth. That ratio began to rise again earlier this year.

The caveat is that household balance sheets are actually in pretty good (or even really good) shape across some developed markets, but at the end of the day, the bottom line is simple: The world isn’t going to pay itself back for $307 trillion in debt incurred. That debt has to be managed with lower rates, managed away with higher inflation or some combination of the two. Currently, policymakers want higher rates and lower inflation. The math doesn’t work.

On Monday, in remarks at Wharton, Neel Kashkari said ongoing economic strength in the US might mean rates “have to go a little bit higher.”