Inflation continues to run hot, and people are starting to notice. In March, the consumer price index (CPI), a measure of consumer inflation, was 8.5% -- the biggest year-over-year change since 1981.
The Federal Reserve is ending many of its pandemic policies in response to these inflationary pressures, including ending quantitative easing (QE), and it is lifting interest rates above their near-zero level. Many investors are concerned about how much interest rates could rise before inflationary pressures subside.
However, JPMorgan Chase (JPM 1.44%) Chief Executive Officer Jamie Dimon isn't overly concerned. That's because the bank has been preparing for higher interest rates than many economists and analysts expect.
Net interest income is the lifeblood of banks
JPMorgan Chase is the largest U.S. bank, so investors listen when Dimon talks. Since last year Dimon has expressed concern about higher and persistent inflationary pressures. The bank has been bracing for higher interest rates, but first, let's look at how banks make money.
Image source: Getty Images.
One of the primary ways a bank makes money is from interest. More specifically, the bank charges customers higher interest rates on loans and pays out a lower rate on customer deposits. The difference between these two is known as the interest-rate spread.
When interest rates are low, banks tend to see a smaller interest-rate spread, which has been the case for the past two years. As a result, banks like JPMorgan rely more on investment banking and other fees to generate income. When interest rates rise, interest-rate spreads widen, and banks can make more money from net interest income.
Rates could rise "significantly higher than the markets expect"
The federal funds rate -- the interest rate set by the Federal Reserve on overnight loans between banks -- is expected to come in at about 2% to 2.25% by the end of the year, up from 0.5% now. However, in Dimon's annual letter to shareholders, the CEO thinks rates could rise "significantly higher than the markets expect."
Image source: Federal Reserve Summary of Economic Projections.
Where interest rates end up is open to debate, but investors can agree that they're going higher. Beyond that, inflation could persist longer than expected, and the Fed may have to do more to cool it down.
What JPMorgan Chase has been doing to prepare for this
Dimon isn't sweating higher interest rates because the bank has been preparing for this scenario for over a year now. JPMorgan Chase has already seen its net interest income increase over the last three quarters. However, this could improve even more in 2022 and beyond.
Data source: JPMorgan Chase. Chart by author.
Dimon saw the bank's liquidity, or cash on hand, as a way to protect it against future inflation. Last year, the bank was very conservative about putting cash to work while interest rates were low, and Chief Financial Officer Jeremy Barnum reiterated that it was "happy to be patient" putting cash to work.
If Jamie Dimon is correct, the bank could be "a port of safety" for investors and fare well in the coming years. It has nearly $625 billion in cash and cash-like assets, up 24% from last year, which can be put to work quickly as interest rates continue their ascent.
