Jamie Dimon, in his annual shareholder letter, highlighted several risks and challenges facing the economy.

He expressed concerns over the rise in private credit, geopolitical tensions, and inefficiencies in government intervention.

Dimon particularly focused on prolonged high inflation due to factors such as restructuring global supply chains, increased military spending, investments in the green economy, and rising healthcare costs.

He suggested that these elements might prevent inflation from returning to the low levels of the past decade, potentially limiting the Federal Reserve’s ability to cut interest rates.

Current market expectations reflect this, anticipating fewer rate cuts than previously thought, which aligns with the real cost of capital indicated by Treasury Inflation-Protected Securities.

Investor Essentials Daily:
The Monday Macro Report
Powered by Valens Research

Last week, Dimon released his annual shareholder letter, which had some important takes in it.

He warned of economic risks, particularly from the surge in private credit due to limited regulation. He also discussed geopolitical risks and the economy’s resilience.

He praised current industrial policies like the IRA and CHIPs Act for their effectiveness but cautioned against inefficient government interventions that could damage the economy.

But, above all, his most crucial point might have been what he had to say about inflation.

Inflation is likely to be higher for longer, and Jamie Dimon cited several reasons.

Firstly, rising geopolitical tensions have triggered the restructuring of global supply chains, leading to increased input costs.

Secondly, there has been an uptick in military expenditures. This is most recently highlighted by President Biden’s proposal for an $850 billion defense budget, a 4.1% increase from 2023.

Thirdly, significant investments are being funneled into the green economy as the U.S. and other nations aim to meet ambitious climate goals.

Finally, healthcare costs are on the rise, fueled by the aging Baby Boomer population and the escalating prices of medical technology and pharmaceuticals.

Combined, these elements are reshaping the inflationary framework, and Dimon suggests that they might prevent inflation from returning to the 1.5% to 2% range we enjoyed for much of the past decade.

Now mind you, that while this doesn’t mean 5-7-9% inflation, it does indicate a potential new normal where inflation might sit much higher than the Fed or investors would care to admit.

And that’s important because that means the Fed may not have as much room to cut interest rates.

The Fed is leading us on and investors are finally beginning to notice…

Currently, the market is anticipating two quarter-point rate cuts in 2024, with a 50% chance of a third cut.

This outlook marks a significant shift from January when the expectation was for six to seven rate cuts.

The changing market sentiment, while still overzealous, underscores a growing realization that there will be fewer rate cuts than initially anticipated.

In fact, this can be illustrated through some simple math…

Treasury Inflation-Protected Securities (“TIPS”) provides a measure of the “real cost of capital” for the U.S. government, meaning they reflect the interest rate after accounting for inflation.

Over the past 30 years, the average TIPS yield—meaning the interest rate adjusted for inflation—has been about 2%.

And if you exclude certain periods of wackiness where real interest rates were negative, the average real interest rate is closer to 2.5%.

Take a look…

Considering a risk-free rate of 2% to 2.5% and adding inflation of 3%, you get to a total interest rate of 5% to 5.5% for the Federal Reserve to realistically be charging.

Right now the Fed sits at a target rate of 5.25% to 5.5%, which is right smack in the middle of this range.

So if Dimon is right, there may not be a lot of cutting for the Fed to do if there’s no recession to push it to do so.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research