The shock of the bear market, inflation and rising interest rates this year for consumers is reflected in huge windfall profits for the world's top banks.

US banks raise interest rates on loans, counting on excess profits

Third quarter reporting season is in full swing, but big tech companies and other consumer favorites are clearly feeling the chill in the buying sector due to rising costs of living, the dollar, and supply chain disruptions.

Quarterly results from majors Microsoft and Alphabet, which is run by parent company Google, disappointed tech bulls late Tuesday, with both stocks down about 7% in the stock market, breaking an earlier bull run in Wall Street stocks. S&P 500 futures fell almost 1% on Wednesday, halving gains on that position on Tuesday.

In principle, Google's results do not bode well for Facebook's parent meta platform (Meta), heavily tied to reports due to its dependence on ads. Apple and Amazon also detailed how their businesses are doing on Thursday in a bid to reassure shareholders and traders.

How far the industry is in crisis can be judged by the fact that chipmakers such as UMC and AMD are reducing capital expenditures in preparation for a protracted economic downturn.

The sadness in the tech stock markets contrasts sharply with the booming profits of banks, which are reaping huge windfalls from rising interest rates - direct cash injections from the reserves they hold at central banks, along with higher net interest margins and trading income, which are favored by market volatility.

For example, the average interest rate on the most popular US mortgage rose to its highest level since 2001 as tightening financial conditions put pressure on the housing sector, data from the Mortgage Bankers Association (MBA) showed on Wednesday. At the same time, the average contract rate on 30-year fixed-rate mortgages rose 22 basis points to 7.16% over the previous week, while the MBA market composite index, which reflects the volume of applications for mortgage loans, fell 1.7% compared to the week before.

This makes one wonder if the negative outlook for prime brokers' losses was wrong. After all, they are still making good profits from the lending sector.

However, this may have a short-term effect.

In particular, mortgage rates have more than doubled since the beginning of the year as the Federal Reserve pursues an aggressive path of raising interest rates to curb stubbornly high inflation. Such growth could not but be reflected in the volume of lending, and now the filing of mortgage applications is at its lowest level since 1997.

This could hit banks' profits as early as the fourth quarter, and especially after the companies' annual reports.

Interestingly, their overseas competitors, who reported this week, caught up in this indicator with their Wall Street counterparts. Now, central banks on both sides of the Atlantic are on the lookout for the European Central Bank meeting this week and meetings of the Bank of England and the US Federal Reserve next week. So far, they are all planning further hikes in the policy rate to curb inflation. But this will surely lead to the fact that the rates on loans for end consumers will also be revised. The public finances may also be at risk.

At the same time, in the consumer sector, the sky is overcast with clouds of inflation. Harsh real sector reports continue to clearly point to a crisis in US consumer and housing confidence.

The rather harsh new reality has even sparked a new wave of discussion about whether the US Fed will soon be forced to slow down the rapid pace of credit tightening.

On October 25, US Senate Banking Committee Chairman Sherrod Brown urged Fed Chairman Jerome Powell to be cautious about tightening monetary policy. He said out loud what became the new unspoken reality: the Fed stopped caring about saving jobs. Sherrod believes that millions of Americans, already suffering from high inflation, will also lose their jobs. He also called the strong labor market overwhelmed by the effects of the Fed's aggressive policies.

Nevertheless, Sherrod's appeal does not contain a direct request to stop raising interest rates or slow down their growth rates. Sherrod is now at a disadvantage: as a Democrat, he has to contend not only with Republicans and their accusations of economic mismanagement during the pandemic, but also with a fall in voter confidence.

But in general he is right.

It is obvious that the growth of interest rates on loans will lead to an increase in unemployment, as companies will be forced to reduce payroll funds in order to save working capital. Against this background, banks' excess profits from lending operations are criticized by the government, and even more so that central banks intend to raise borrowing rates even more.

This makes me think that perhaps banks will end up being, if not the least affected sector in the stock market, then at least the most protected. Obviously, the crisis will hit them last, when and if the market turns into a real bear market. Until then, especially with the cushion of government loans accumulated over the previous two years, the financial sector is likely to fare well. Given this, shorting Goldman Sachs or Morgan Stanley looks like a good alternative during this period of high volatility in other sectors.

The US central bank is expected to raise rates by 75 basis points for the fourth consecutive time after its next policy meeting on November 1-2. The Bank of Canada is likely to raise rates by another three-quarters of a percentage point to a new 14-year high.

However, some investors further expect that Powell will reduce the rate of suppression of inflation. This is due not only to the fall in purchasing power. Rising energy prices are also gradually declining, especially natural gas prices in Europe.

Accordingly, hopes for some respite of the fears of the Fed again led to a decrease in the yield of long-term bonds and the US dollar. And 10-year bonds, in turn, act as a benchmark for housing loan rates.

It looks like Powell can really slow down with new additions to the base rate, but don't count too much on it. Nevertheless, the leading indicator for the central bank is data on price growth, and it is on them that it will ultimately focus.