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On Wednesday, at the Federal Open Market Committee (FOMC) Meeting, the Federal Reserve announced the awaited increase in the benchmark federal funds rate in 2016. The interest rate was hiked to 0.50%–0.75% from 0.25%–0.50% raised in Dec 2015.
Notably, following the 2008 financial crisis and the Great Recession, which came to end in mid 2009, the FOMC decreased the rate to zero, almost eight years ago on Dec 16, 2008. In Dec 2015, the Fed’s expectations were to raise rates four times in 2016, but global economic uncertainty, followed by Brexit, halted the Fed’s move.
In a press conference following the decision, Federal Reserve Chairwoman Janet Yellen said: “My colleagues and I are recognizing the considerable progress the economy has made toward our dual objectives of maximum employment and price stability… We expect the economy will continue to perform well, with the job market strengthening further and inflation rising to 2 percent over the next couple of years.”
The Fed had been cautious due to the overall weak economic data during first two quarters of 2016, however economic growth started to moderate from mid year. Therefore, with decent economic growth, recent strong gains in the labor market, including a November jobs report showing unemployment down to 4.6%, and inflation target expected to return to the Fed’s 2% target, rate hike is an added advantage.
Following the interest rate hike announcement, most of the Wall Street biggies, including Wells Fargo & Company (WFC - Free Report) , The PNC Financial Services Group, Inc. (PNC - Free Report) , Citigroup Inc. (C - Free Report) and Bank of America Corp. (BAC - Free Report) , increased their prime lending rate to 3.75%, effective Dec 15, 2016.
President Donald Trump's proposed infrastructure spending plans, tax cuts and reduced regulations are likely to spur economic activity, resulting in rise in inflation, leading to further hike in rates.
Notably, BofA with a Zacks Rank #1 (Strong Buy) and PNC Financial with a Zacks Rank #2 (Buy) reflected investors’ optimism with their shares rising 33.4% and 18.2%, respectively, since the presidential election till date. You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.
Further, Wells Fargo and Citigroup’s shares rose 20.1% and 19.1%, respectively.
Fed policymakers projected three rate increases in 2017, up from their expectations of two in September. However, they have maintained their anticipation of three hikes each in 2018 and 2019. Its long-run rate is projected to be 3%, up slightly from the previous forecast of 2.9%. The Fed maintained its expectation of rate increases to be "gradual."
Consumer discretionary, financial and technology are the sectors most affected by the prolonged lower-interest rate scenario. Most financial entities like banks, insurance companies, brokerage firms and money managers will benefit from rising rates as margins expand, though consumption and investment will decrease.
The interest rates hike, though at a slower pace, will ease some pressure on net interest margin (NIM) – a key source of banks’ earnings. Also, banks will earn more from the money that they need to keep at the Fed, compared with low income from this source in the low-rate environment that has prevailed since the last financial meltdown.
We believe that any expansion in net interest margins would be a positive for banks’ profitability. Precisely, banks maintaining securities portfolios with short durations could benefit from the rising short-term rate scenario through higher reinvestment rates. Rising rates may increase banks’ profitability; however rapid increase may dent their health. A rising interest rate could widen the spread for certain banks.
However, rising rates, without support of significant economic recovery, would affect profitability in many sectors of the economy, on which banks depend for their earnings. Moreover, the balance sheet is affected when rising interest rates change the value of liabilities and assets, and reduce net worth of the banks. Due to maturities gap, bank assets and liabilities are impacted differently by an interest rate rise. If assets lose value while the liabilities are intact, the net worth drops, affecting their capital levels.
Nonetheless, the rate-hiking cycle will be gradual and the frequency will depend on the performance of the U.S. economy. So, the borrowing costs for consumers and businesses are not expected to extensively increase in the near term.
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Fed Rate Hiked to 0.50-0.75%, Positive for Banks?
On Wednesday, at the Federal Open Market Committee (FOMC) Meeting, the Federal Reserve announced the awaited increase in the benchmark federal funds rate in 2016. The interest rate was hiked to 0.50%–0.75% from 0.25%–0.50% raised in Dec 2015.
Notably, following the 2008 financial crisis and the Great Recession, which came to end in mid 2009, the FOMC decreased the rate to zero, almost eight years ago on Dec 16, 2008. In Dec 2015, the Fed’s expectations were to raise rates four times in 2016, but global economic uncertainty, followed by Brexit, halted the Fed’s move.
In a press conference following the decision, Federal Reserve Chairwoman Janet Yellen said: “My colleagues and I are recognizing the considerable progress the economy has made toward our dual objectives of maximum employment and price stability… We expect the economy will continue to perform well, with the job market strengthening further and inflation rising to 2 percent over the next couple of years.”
The Fed had been cautious due to the overall weak economic data during first two quarters of 2016, however economic growth started to moderate from mid year. Therefore, with decent economic growth, recent strong gains in the labor market, including a November jobs report showing unemployment down to 4.6%, and inflation target expected to return to the Fed’s 2% target, rate hike is an added advantage.
Following the interest rate hike announcement, most of the Wall Street biggies, including Wells Fargo & Company (WFC - Free Report) , The PNC Financial Services Group, Inc. (PNC - Free Report) , Citigroup Inc. (C - Free Report) and Bank of America Corp. (BAC - Free Report) , increased their prime lending rate to 3.75%, effective Dec 15, 2016.
President Donald Trump's proposed infrastructure spending plans, tax cuts and reduced regulations are likely to spur economic activity, resulting in rise in inflation, leading to further hike in rates.
Notably, BofA with a Zacks Rank #1 (Strong Buy) and PNC Financial with a Zacks Rank #2 (Buy) reflected investors’ optimism with their shares rising 33.4% and 18.2%, respectively, since the presidential election till date. You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.
Further, Wells Fargo and Citigroup’s shares rose 20.1% and 19.1%, respectively.
Fed policymakers projected three rate increases in 2017, up from their expectations of two in September. However, they have maintained their anticipation of three hikes each in 2018 and 2019. Its long-run rate is projected to be 3%, up slightly from the previous forecast of 2.9%. The Fed maintained its expectation of rate increases to be "gradual."
Consumer discretionary, financial and technology are the sectors most affected by the prolonged lower-interest rate scenario. Most financial entities like banks, insurance companies, brokerage firms and money managers will benefit from rising rates as margins expand, though consumption and investment will decrease.
The interest rates hike, though at a slower pace, will ease some pressure on net interest margin (NIM) – a key source of banks’ earnings. Also, banks will earn more from the money that they need to keep at the Fed, compared with low income from this source in the low-rate environment that has prevailed since the last financial meltdown.
We believe that any expansion in net interest margins would be a positive for banks’ profitability. Precisely, banks maintaining securities portfolios with short durations could benefit from the rising short-term rate scenario through higher reinvestment rates. Rising rates may increase banks’ profitability; however rapid increase may dent their health. A rising interest rate could widen the spread for certain banks.
However, rising rates, without support of significant economic recovery, would affect profitability in many sectors of the economy, on which banks depend for their earnings. Moreover, the balance sheet is affected when rising interest rates change the value of liabilities and assets, and reduce net worth of the banks. Due to maturities gap, bank assets and liabilities are impacted differently by an interest rate rise. If assets lose value while the liabilities are intact, the net worth drops, affecting their capital levels.
Nonetheless, the rate-hiking cycle will be gradual and the frequency will depend on the performance of the U.S. economy. So, the borrowing costs for consumers and businesses are not expected to extensively increase in the near term.
Zacks' Top Investment Ideas for Long-Term Profit
How would you like to see our best recommendations to help you find today’s most promising long-term stocks? Starting now, you can look inside our portfolios featuring stocks under $10, income stocks, value investments and more. These picks, which have double and triple-digit profit potential, are rarely available to the public. But you can see them now. Click here >>