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Rising Interest Rates: Bull Versus Bear Scenarios

Retail Banking, Price Optimization | Jan 19, 2022
Rising Interest Rates: Bull Versus Bear Scenarios

Industry buzz suggests that we will soon see Fed funds, and subsequently, retail and commercial deposit rates, rise in 2022 or 2023. Banks are anxious to see an expansionary rate regime to push open net interest margins and thus, signal the improving demand for loans. Tepid loan demand and rock-bottom margin spreads have been an anchor on bank earnings over the past year and we are collectively anxious to return to a more traditional rate curve. However, the current sentiment around rising rates being just over the horizon is based on the current trajectory of the economic curve.

Inflation has been prevalent across news and media headlines lately, and for good reason. Supply chains remain somewhat disrupted due to Covid-19 adaptations, the demand for goods is rising, and there is excess liquidity in the money supply. Together, these three forces are lifting prices higher. On the one hand, recent growth in core consumer prices, commodities, equity values, and real estate prices give concern that the market is exuberant. On the other hand, unemployment remains high, and Spring 2020 saw the sharpest economic contraction in modern history. The current trajectory of the economy could be an indication that we are getting “back on track.” All of that considered, the next chapter in this story can go one of two ways: recovery or correction.

There are bullish and bearish theories about where the market is headed next, be it recovery or correction. Let’s look at a summary of market forces contributing to both camps holding steady.

The Bullish Case
The theory that the economy will continue to expand is based on several premises. 

  • Vaccine related reopening will unleash pent-up demand.
  • Direct government stimuli have added trillions of dollars to the money supply that will be spent and re-spent.
  • Consumer and business borrowing is down overall, improving credit quality.
  • Banks are better capitalized, and mortgage qualifications are tighter than in 2007.
  • Stocks (i.e., Crypto, real estate, NFTs, commodities or IPOs/ SPACs) only go up.

The Bearish Case
This theory offers a view of why the current economic trajectory is unsustainable.

  • Low treasury yields are driving yield-seeking behavior and inflating asset prices.
  • Equities are overvalued and overdue for a correction.
  • Margin debt is at an all-time high.
  • Direct government stimulus is coming to an end.
  • Forbearance on mortgages, student loans, and moratoriums on evictions will end soon.
  • Inflation is increasing and may force the Fed to raise rates.
  • The Federal Reserve balance sheet growth is unsustainable and QE programs will taper soon.
  • Commercial real estate has not yet felt the impact of vacancy or moratoriums.

Whether you believe the bearish or bullish case for the future, this much is clear: waiting for NIM expansion will not improve your bank’s performance today. Rather, the ability to deliver personalized, contextual rates and offers to clients in both deposits and lending will separate the new “relationship” banks from those of the past.

Dive deeper into detailed specifics on each potential scenario, and learn more about the Federal Reserve’s possible rate response in Nomis’ recent white paper titled: RISING RATES 2023: Bull Versus Bear Scenario.