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Fed Announces 2018's Third Rate Hike: 5 Bank Picks

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On Sep 26, the Federal Reserve hiked its benchmark interest rate by 0.25%, a move that was widely expected. It also laid out a path for monetary policy moves up to 2021. More significantly, the central bank clearly indicated that it was shedding its accommodative monetary policy stance.

An increase in rates widens the yield spread for banks, which, in turn, boosts their margins. However, comments by the Fed Chair on inflation immediately after the release of the policy statement sent Treasury yields, and, consequently bank stocks tumbling.

However, bank stocks are likely to retain their attractiveness even as the yield curve flattens. This is because conventional bond proxies such as utilities, REITs and consumer staples will fall out of favor in this environment. Instead, it would make sense to invest in banks, which will gain from higher interest margins.

Another Rate Hike Likely in 2018

The Federal Reserve has increased the benchmark overnight lending rate by 0.25%. This effectively boosts the rate to a range of 2 to 2.25%. The last time the rate was at this level was in April 2008. This is the third rate hike of the year and the eighth since the Fed began taking a more hawkish stance since December 2015.

Further, the central bank estimates that another rate hike will take place before the year ends. Three more will be announced in 2019 and only one will occur the following year. This entire series of increases would take the fed funds rate to 3.4%, almost 0.5% above the Fed’s projected “neutral” rate.

At this level, rates do not boost or constrict economic expansion. In a fresh sign that the Fed continues its process of normalization, the central bank refrained from using the phrase “accommodative” to describe monetary policy.

Inflation Surprises to the Upside Unlikely, Says Fed Chair

The Fed also raised its growth projection for the current year to 3.1% from the 2.8% estimate released in June. The central bank now believes that GDP will clock in at 2.5% in 2019 before decelerating to hit 2% in 2020 and 1.8% in 2021. This slowdown in the pace of growth will likely occur as the effect of a step-up in government spending and dwindling tax cuts.

A rate hike and higher economic growth are factors that are usually beneficial for banks. However, comments by the Fed Chair Jerome Powell at a press conference immediately after the release of the policy statement sent bank stocks lower.

Powell was asked what factors could lead to an increase in the pace of rate hikes. The Fed Chair thinks that only if inflation exceeds forecasts would the Fed raises rates even faster. However, the Fed Chair opined that such a situation was highly unlikely. His comments sent the 10-year Treasury bond yield lower.

Subsequently, financials, which are sensitive to rates, declined. The S&P 500 financials sector lost 1.2%, its sharpest fall since Jul 19. Shares of Goldman Sachs (GS - Free Report) , Morgan Stanley (MS - Free Report) and JPMorgan (JPM - Free Report) each lost in excess of 1%.

Our Choices

Wednesday’s losses for bank stocks are a direct outcome of a slide in interest rates. This, in turn, was caused by the Fed Chair’s comments on inflation. But the decline is likely temporary. In an environment characterized by higher rates and a flattening yield curve, conventional bond proxies, like utilities, are likely to suffer.

Instead, it would make sense to add bank stocks to your portfolio, since they will enjoy higher interest margins. We have narrowed our search to the following stocks based on a good Zacks Rank and other relevant metrics.

CBTX, Inc. (CBTX - Free Report) is the bank holding company for CommunityBank of Texas National Association, which offers commercial banking services to businesses and professionals.

CBTX has a Zacks Rank #1 (Strong Buy). The company has expected earnings growth of 25.9% for the current year. The Zacks Consensus Estimate for the current year has improved 8% over the past30 days.

The First Bancshares, Inc. (FBMS - Free Report) is the parent company of The First, A National Banking Association that offers banking services to business and individuals.

The First Bancshares’ expected earnings growth for the current year is 27.8%. The Zacks Consensus Estimate for the current year has improved 2.3% over the past 60 days. The stock has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

BOK Financial Corporation (BOKF - Free Report) is a regional financial services company, providing a range of offerings, which includes commercial and consumer banking.

BOK Financial has a Zacks Rank #2 (Buy). The company’s expected earnings growth for the current year is 30.5%.  The Zacks Consensus Estimate for the current year has improved 0.4% over the past30 days.

SVB Financial Group (SIVB - Free Report) operates through, among others, the Silicon Valley Bank, its primary subsidiary, providing a wide range of banking and financial products and services.

SVB Financial has a Zacks Rank #2. The company has expected earnings growth of 74.4% for the current year. The Zacks Consensus Estimate for the current year has improved 0.6% over the past30 days.

First Bancorp (FBNC - Free Report) is a one-bank holding company. The principal activity of the company is the ownership and operation of First Bank.

First Bancorp has a Zacks Rank #2. The company has expected earnings growth of 63.4% for the current year. The Zacks Consensus Estimate for the current year has improved 0.4% over the past30 days.

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