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What's in the Cards for Bank Investors in FOMC Meeting?

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The Federal Reserve will wrap up its two-day policy-setting meeting later today and come out with new set of economic projections. Though the central bank is not likely to take any policy change action, all eyes will be on any clues as to when the bond buying program will be tapered and interest rates raised.

In the April FOMC meeting, the Fed officials had signaled that interest rates will be held down at near-zero at least till 2023-end. But this could change now. There are chances that the Fed officials may point to possible hike in interest rates in 2023.

What happened since the last meeting that might have changed the Fed’s stance? Well, since then, the economy has been re-opening, which along with favorable data, has increased optimism about a faster-than-expected economic growth. Also, the coronavirus infection rate is falling and vaccination coverage is improving.

These developments show that the economic growth will be robust this year. Per the Fed’s last Summary of Economic Projections, the U.S. economy will grow at rate of 6.5% in 2021, with unemployment rate of 4.5% and core inflation of 2.2%. These numbers are now highly likely to be revised upward.

Also, before raising interest rates, the central bank will have to wind down its asset purchase program. Though there hasn’t been any concrete plan for the same, the chances are high that the Fed will signal a timeline for it. At present, it buys nearly $120 billion per month in bonds in order to keep markets flowing and financial conditions loose.

Per the April FOMC meeting minutes (released in May), several Fed officials seem to be ready to start thinking about tapering the program. The minutes stated, “A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”

What’s in Store for Bank Stocks Amid All This?

We know that banks thrive in the rising rate environment. So, when the Fed cut short-term interest rates to near-zero last year amid the pandemic, banks faced a tough operating backdrop. This, along with economic slowdown and faltering loan demand, substantially hurt banks’ profitability.

In 2020, the SPDR S&P Regional Banking ETF and KBW Nasdaq Bank Index were down 8% and 14.6%, respectively. Similarly, the Zacks Major Regional Banks industry and Zacks Banks & Thrifts industry lost 17.2% and 10.5%, respectively. Nevertheless, the S&P 500 Index rallied 18.6% over the same time frame.

Price Performance in 2020

Zacks Investment ResearchImage Source: Zacks Investment Research

 

Since then, the trend has been reversing. Optimism surrounding the bank stocks is primarily driven by the expectation of an accelerated recovery of the sector along with above-mentioned favorable developments.

Banks seek to borrow money at short-term rates and lend at long-term rates. Now that long-term rates are rising, the yield curve is steepening. Year to date, the yield on the 10-year U.S. Treasury has surged almost 60 basis points. Thus, almost all banks – big and small – which faced net interest margin compression last year, are expected to witness some improvement in the same.

Also, as interest income constitutes a major portion of banks’ revenues, steepening of the yield curve, along with gradual rise in demand for loans, will support the same. Hence, banks including JPMorgan (JPM - Free Report) , Bank of America (BAC - Free Report) , Huntington Bancshares (HBAN - Free Report) , BOK Financial Corporation (BOKF - Free Report) and Zions Bancorporation (ZION - Free Report) are expected to witness solid top-line growth.

Another main driving factor for banks’ financials is the overall health of the nation. The assumption that the central bank will revise its economic growth forecast upward again will provide further support to the banks.

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