Alden Energy Strategist: Will Energy Be First or Last
March 28, 2019
U.S. Bank Statistical Report (April 2019)
April 2, 2019
Slower economic growth and unfavorable yield curve present challenges, still anticipating modest EPS growth for banks in the first quarter of 2019.
The economy continues to perform well in 2019, though there’s no question that the pace of growth has slowed compared to 2018. The stimulative policies that drove growth in 2018, reduced tax rates and increased Federal spending, seem to have expended the energy they had to pump economic growth. Meanwhile, tariffs and trade policy have provided alternating episodes of optimism and pessimism in recent months, driven by the changing sentiments surrounding negotiations with China. Still, trade policy remains a significant worry for investors. Inflation seems to be off the table for the time being, as most measures have fallen below the Fed’s 2.0% target rate in recent months. This has led to a sharp change in expectations about interest rates. Over the last three or four months, the market has shifted from expecting continued Fed rate hikes in 2019, to some back and forth over whether the Fed will stay put or actually institute rate cuts this year.
Economic indicators continue to show expansion, though recent readings of several indicators suggest the pace of growth may be slowing. GDP growth has been stronger for the last few quarters than it has been for years. The initial estimate of 4Q18 GDP came in at 2.6%, exceeding the consensus expectations for roughly 2.2% growth. This results in full year GDP growth of 3.1%. We still expect GDP growth to decline in 2019 to somewhere in the 2.0%-2.5% range. Meanwhile, employment growth suffered a setback in February, coming in at just a 20k rise and dropping the three-month moving average down to +186,000, a 59,000 decline from the previous month. Still, the unemployment rate was reported at 3.82%, which is still close to the lowest level in decades. The Core PPI (up 2.45% YoY) and Core CPI (up 2.08% YoY) both remain above the Fed’s 2.0% target, but the Fed’s favored measure, the Core PCE Deflator fell to 1.75% YoY in the most recent reading for December. Though we have concerns about the possible future impact of stimulative fiscal policies and tariffs on inflation, there seems to be little inflationary pressure on wages or on prices at this time.
With the yield curve continuing to flatten, and even inverting slightly, we believe the benefits for banks from the rise in short-term rates has run its course. It appears that slowing economies overseas and slower growth in the U.S. are keeping long-term interest rates low. The end of Fed rate hikes on the short end of the curve should reduce deposit pricing pressures over the remainder of the year, but we still believe that margin expansion will be difficult, at best, for most banks. We still believe that banks with lots of core deposit funding, particularly in noninterest bearing accounts, will fare the best in this environment. We believe that economic activity remained solid in 1Q19, and the pace of GDP growth, while probably down from the pace in 4Q18, is likely to remain favorable. Consequently, we believe the current environment remains favorable for solid loan demand going forward. We foresee a good year for C&I, CRE and consumer loan volumes, while lower mortgage rates could support this segment as well. Core deposit growth may be more difficult, and banks may continue to consider utilizing higher-cost CDs to fund loan growth, putting additional pressures on net interest margins. With no indications of any broad deterioration in asset quality, we believe that bottom line results for most banks will continue to show modest sequential quarter and year-over-year improvements in 1Q19.
