KBRA Financial Intelligence

3 Things in Credit: Inauguration Bluster, Big Bank Credit Color, and Sentiment Shift

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.

This past week, I caught Jeffrey Gundlach’s latest webinar on market trends, which is always an informative view. His presentation was titled “Man Leaving a Bus: What Does It Mean?” It was accompanied by a photo of a life-size sculpture by George Segal bought by Mr. Gundlach at auction of, well, a man exiting a bus. Alright, I’ll bite, what does that mean to markets? According to Mr. Gundlach, it represents secular change, leaving one environment for another. In the economy and markets, we’re leaving an environment of the past 40 years where fiscal discipline has turned reckless. And where our economy, now heavily services based, responds differently to monetary policy. It mirrors a theme we’ve emphasized throughout the pandemic and post-pandemic period—this time is different. We’ve left the bus.

This week, our 3 Things are:

1. Inauguration bluster. Don’t expect nuance on Monday.

2. Big bank credit color. Nothing new here is great news.

3. Sentiment shift. Small Business’s clouds have lifted.

Alright, let’s dig a bit deeper.

Inauguration bluster.

We’ve got three big data items to kick off 2025: December jobs, December PPI/CPI, and, in case you’ve lost track, Monday brings us the incoming U.S. president’s inaugural address. It’s not just any U.S. president that can create market-moving comments on day one of his term, but this one can. More on that in a second.

Let’s start with the December jobs print, 256,000, which blew away the estimate (165,000), and all but one of the 75 estimators (a tip of the cap to you, Bloomberg Economics). The result clearly reflects the ongoing strength of the U.S. economy. And peeling the onion a bit, we find really healthy growth in private payrolls and reasonably well-behaved wage gains. So, this report is clearly good for credit. Well, needless to say, this was not well received by markets, which are back on inflation watch. And this report suggests fewer rate cuts. So, while higher for longer presents a headwind, credit investors should be OK with that, as long as growth sustains north of 2%, unemployment remains at structural lows, and corporate earnings growth remains solidly positive.

Speaking of inflation, we did get reassuring news this week that tamped down some of that hot economy angst, with both PPI and CPI coming in softer than expected. The read across to PCE, the Fed’s preferred inflation measure, suggests something at or around 2.5%. And when you factor in upcoming favorable base effects in the first four months of the year, the inflation story—based on what we know today—looks to be fairly benign.

Which brings us to … that inauguration address.

Peter Tchir over at Academy Securities set the inauguration stage this way: “Trump likes to create noise. Anytime you think things are good … expect noise the other way … expect Trump to do the unexpected.”

I think that’s the right way to think about Trump’s pronouncements. At his first inauguration address eight years ago, we got Trump noise in the form of “American Carnage,” or as former president George W. Bush allegedly said, “some weird” … ugh … to use a podcast-friendly term, “stuff.” This go around, market watchers are looking for a clearer definition of Trump’s policy leanings, especially those likely to be inflationary—namely tariffs, limits on immigration, and tax cuts. We would expect all of those to be teased in his address, and two of the three—tariffs and deportations—could quite possibly show up in what press reports say could be more than 100 day-one executive orders.

On balance, the more influential inflation news of late is the cooling PPI/CPI reports this week. Still, we have to contend with Trump noise on tariffs, immigration, and tax cuts going forward. And those figure to lean on FOMC and investor sentiment, thereby strengthening a higher-for-longer rate environment over the course of 2025.

Alright, on to our second Thing—Big bank credit color.

The big banks are having a good run. Over the past year, bank stocks have outperformed the S&P by some 22 points, reflecting a recovery in credit and equity investor sentiment driven first by a stronger-than-expected economy, falling inflation, and the prospects of rate cuts, and more recently, by the reappearance of a positively sloping yield curve and the U.S. elections and their promise for financial services deregulation and further consolidation at least for smaller banks. Phew! That’s a lot of tailwinds at the back of the banking sector heading into 2025.

But, as always, in trying to look around the corner for signs of credit market health, the largest lenders—the banks—are a great place to look for clues.

JPMorgan Chase acknowledged that we are closer to normalized credit costs, having said repeatedly in the past that the bank had “over-earned” in lending due to the highly accommodative fiscal and monetary response to the pandemic that resulted in lower loan losses. Nonperforming assets grew 28% year on year—there’s that normalization—but nonaccrual loans to total loans went from a very low 0.52% to a, well, very low 0.65%. Loan losses were also very low on the commercial side and low on the consumer side. The credit card loss rate came in at a low 3.3% in Q4, and management is guiding 2025 losses to be a low 3.6%. Overall loan loss reserves as a percentage of loans were built modestly over the course of the year. Management’s only cautionary comment with regard to credit is that “it’s important to acknowledge the tension in the risks and uncertainties in the environment” so the bank has prepared for “a wide range of scenarios.” CEO Dimon reminded that the biggest driver of credit costs “has been and always will be unemployment.” He also mentioned stagflation—higher rates and higher unemployment—as a bear case scenario.

Bank of America also reported stable and high asset quality indicators, from the lagging indicator—the loan loss ratio—to the forward-looking nonperforming asset ratio and reserve development. Consumer credit risk trends have normalized to favorable levels, and office loan losses are in decline. When describing credit quality trends, management mentioned that “there's nothing really noteworthy here that I want to highlight.” I couldn’t disagree more. Stable and high loan quality is, quite simply, the most important thing you could say to investors. It speaks to effective risk control and the strength of the economy.

Guidance for 2025 forecasts a loan loss rate between 50-60 bps, consistent with 2024’s quite reasonable level. Management does caveat the view with an assumption that there is “no material shift in macroeconomic environment.” BofA did provide color on its $15.1 billion office portfolio, notably that 11% is nonperforming and 34% is “criticized,” a regulatory standard for stressed. For perspective, that criticized amount—$5.1 billion—is equivalent to just over half of one-quarter’s pretax, pre-loan loss provision income.

Over at Wells Fargo, CEO Scharf said the U.S. economy has performed “very well” and is positioned to remain that way “well into 2025.” He believes the incoming administration has signaled “a more business-friendly approach to policies and regulation, which should benefit the economy and our clients.” The bank’s credit quality overall is stable with low loan losses and nonperformers. The lone weak spot is commercial real estate, where management characterizes office fundamentals as “weak.” CRE accounts for roughly half of total nonaccruals, and two-thirds of commercial loan losses.

Overall, all three of these results paint a credit environment that is remarkably strong with the lone exception of lending on office buildings. And remember, the most vulnerable subsector of office lending is on larger, downtown properties, the kind of exposures that are concentrated in the largest banks, which, of course, are best positioned to handle the gradual bleeding of losses.

One other point worth making here. The largest banks skew their lending businesses to higher-quality borrowers in both consumer and commercial sectors, both of which are flourishing. As we go through earnings season, we’ll get a better look at how the weaker part of our “Two Economies”—less wealthy households and smaller businesses—is faring.

Alright, on to our third Thing—Small business sentiment shift.

Sometimes, you just need change. By almost any measure, President-elect Trump is inheriting a strong economy today, and one that is well positioned to flourish in the future. But the change represented by Trump 47, especially deregulation, is catalyzing growth among the sector—small business—that accounts for 50% of American jobs and nearly half of its economic output.

At least that’s what the latest survey out of the National Federation of Independent Business suggests. Its Optimism Index has soared in the two months since the election to its highest level since, well, the middle of Trump 45 in 2018, and, at 105, it is comfortably above its 51-year average of 98.

Respondents have registered positive momentum in their outlook for improved conditions overall, as well as expectations for higher sales and expansion of their businesses.

Consumer sentiment, as measured by the University of Michigan, had been recovering in the back half of Biden’s term that saw the index plunge to historic lows. The latest read on both current conditions and future expectations has flattened out at levels below long-term averages. A paper by Larry Summers in 2024 concluded that borrowing costs and credit availability are underappreciated factors weighing on consumer sentiment. Higher for longer—with its 24% credit card, 7% mortgage, and 12% used car loan rates—is not likely to help.

So, there you have it, 3 Things in Credit:

1. Inauguration bluster. The policy fog begins to lift.

2. Big bank credit color. Nothing new here is great news.

3. Sentiment shift. Gathering animal spirits.

As always, thanks for joining. We’ll see you next week.