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What Does Fed's December Meeting Mean for Banks in 2022?

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In the final monetary policy decision for 2021, Federal Open Market Committee (“FOMC”) outlined plans to accelerate the speed to pare its bond purchases, thereby, winding up the quantitative easing program a few months earlier than expected. A quicker conclusion to the bond-buying efforts will position the central bank to hike the ultra-low interest rates next year (possibly thrice) sooner than expected.

With the increased probability of an interest rate hike next year, the S&P Banks Select Industry Index also climbed, albeit marginally. Also, SVB Financial Group (SIVB - Free Report) , East West Bancorp, Inc. (EWBC - Free Report) and BOK Financial Corporation (BOKF - Free Report) rallied 3.4%, 2.1% and 1.8%, respectively, mirroring investor optimism due to the favorable development. Major indexes like the Dow and the S&P 500 increased 1.08% and 1.63%, respectively, by the closing bell.

Owing to inflation at nearly a four-decade high and the unemployment rate reaching the pre-pandemic levels, the Fed continues to take a more hawkish stance. Unsurprisingly, there were no changes in the target range for the federal fund rate at the end of the two-day FOMC meeting yesterday. The federal fund rate remains at 0-0.25%, which the central bank had cut last year amid the coronavirus pandemic.

Per the Fed’s latest statement, “In light of inflation developments and the further improvement in the labor market, the Committee decided to reduce the monthly pace of its net asset purchases by $20 billion for Treasury securities and $10 billion for agency mortgage-backed securities”.

With this, the central bank has doubled the taper moves announced in November. Prior to this, the central bank had been purchasing $120 billion of treasuries and mortgage-backed securities per month to support the economic recovery.

What Does the New Set of Economic Projections Show?

The central bank also upped its economic growth projections. Per the Fed’s latest Summary of Economic Projections, the U.S. economy is anticipated to grow at a 4% rate for 2022, up from the previously mentioned 3.8%. The pace of growth is then expected to cool down over the following two years, with 2.2% growth for 2023 and 2% for 2024.

Based on the updated economic projections, the Fed expects inflation to be 2.6% in 2022, above its target of 2% and marginally higher than the previously stated 2.2%. The unemployment rate in 2022 is predicted to be 3.5%, down from the earlier mentioned 3.8%.

All 18 policymakers have also indicated the possibility of at least one rate hike before 2022 end. Interest rates, which have been low since March 2020, might climb to 2.1% by 2024 end.

What’s in it for Banks?

Owing to the Federal Reserve’s accommodative monetary policy stance and near-zero interest rates, banks have been witnessing pressure on the net interest margin (NIM) since March 2020. Notably, NIM of the likes of East West Bancorp, SVB Financial and BOK Financial has witnessed downward pressure since 2019 through third-quarter 2021 due to a fall in rates.

Hence, the faster-than-expected rate hike comes as a breather for banks and will improve margins and net interest income (NII), which accounts for a major part of the top line. Economic rebound is also set to drive loan demand, substantially improving banks’ profitability.

Excess liquidity on the balance sheet, which had been hindering margins, will likely positively impact asset sensitivity for most banks in a rising rate environment due to the short-duration, high-beta nature of cash.

As of Sep 30, 2021, East West Bancorp, SVB Financial and BOK Financial had cash and cash equivalent balances of $4.9 billion, $18.94 billion and $1.89 billion, respectively. Hence, with any rise in interest rates, the excess cash can be deployed in high interest-earning avenues, aiding interest income growth.

At present, East West Bancorp carries a Zacks Rank #2 (Buy). SVB Financial has a Zacks Rank of 3 (Hold), currently. BOK Financial presently sports a Zacks Rank of 1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

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