The Federal Reserve is set to wrap up its two-day policy-setting meeting on Wednesday. As the result day approaches, speculation on the Fed’s action is growing.
As the current inflation rate remains below the Fed’s target level, chances of an interest rate hike are low this time around. However, this time around, investors are waiting for another important decision that might significantly benefit banks.
In the June meeting, the Fed had hinted that it would start unwinding its huge balance sheet by the end of 2017. And rumours suggest that the trimming might start in September itself and investors are expecting this meeting to specify how the process will be rolled out.
The Fed’s quantitative easing policy during the recession to increase money supply in the economy and support the struggling banking industry made it purchase a large number of financial assets from banks.
Of the assets purchased, most were treasuries and mortgage-backed securities. The Fed kept on reinvesting the proceeds of the maturing securities. As a result of this, its balance sheet now stands at a whopping $4.5 trillion.
However, now, as the economy has more or less stabilized, the Fed wants to start unwinding its balance sheet.
For this, it may either sell some of its securities or stop reinvesting the proceeds.
If the Fed decides to buy back some or all the short-term duration securities, the yield curve will become steeper. This means that the yield on long-term bonds will increase.
Since banks borrow at the short-term rates but lend at long-term rates, their net-interest margin spreads will widen.
Major banks like JPMorgan Chase & Co. (JPM - Free Report) , Bank of America Corporation (BAC - Free Report) , BB&T Corporation (BBT - Free Report) , The Bank of New York Mellon Corporation (BK - Free Report) and Comerica Incorporated (CMA - Free Report) have already been witnessing a gradual improvement in their margins with the rate hikes so far. They will benefit further if the Fed’s balance-sheet action steepens the yield curve.
Although the balance sheet trimming is a long and gradual process, it will definitely help banks to improve their margins further.
Each of the banks mentioned above currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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