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Fed Hikes Rate to 2.00-2.25%, Time to Rejoice for Banks?

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The Federal Reserve (Fed) announced the third rate hike of 2018 at the Federal Open Market Committee (FOMC) Meeting, this Wednesday, under chairman Jerome Powell, as broadly expected by markets. The Fed was tempted by the strengthening economy, optimism on reaching the inflation target this year and impressive labor market gains.

Nonetheless, the Fed will continue with its plans of steadily tightening monetary policy on expectation of at least three more years of U.S. economy growth.

The benchmark federal funds rate has been hiked to 2.00-2.25% from the 1.75-2.00% raised in June. Notably, the last time the interest rate met this range was in April 2008.

 

This is the eighth increase in interest rates since the financial crisis, which led the Fed to lower rates to nearly zero from December 2008. Since then, normalization of policy has been targeted by the central bank through regular but steady rise in rates.

Therefore, with the recent move in the normalization process and the rate, changes in the Fed’s statement indicate that its policy will not likely be “accommodative” any longer. Further, Fed officials stated that “risks to the economic outlook appear roughly balanced”, in the statement.

Following the interest rate-hike announcement, most Wall Street biggies, including Wells Fargo (WFC - Free Report) , The PNC Financial Services Group, Inc. (PNC - Free Report) , Citigroup Inc. (C - Free Report) and Bank of America (BAC - Free Report) , increased their prime lending rate to 5.25%, effective Sep 27, 2018.

Other Economic Projections

Along with the interest-rate hike, policymakers sounded more optimistic for U.S. economy growth. Policymakers increased their expectations for economic growth, though continued with their projections of one more hike in 2018. Furthermore, three anticipated hikes in 2019 and one in 2020 was also reiterated.

The central bank projects economic growth at the rate of 3.1% in 2018, up from the previous expectation of 2.8%, attributed to the encouraging U.S. consumer confidence. In addition, growth rate is anticipated to be 2.5% in 2019 — moderately higher than the June forecast of 2.4%. Projection for 2020 remained at 2%.

Notably, policymakers came out with 2021 projections for the first time, with expectation of 1.8% economic growth. Though projections for expansion of growth have been increased for this year and the next, Fed officials anticipate the same to slow down thereafter, as impact of recent tax cuts and government spending will subside.

Following a two-day meeting in Washington, the FOMC said in its statement, growth and job gains have been “strong” and inflation remains near the central bank’s 2% target.

Therefore, based on the updated economic projections, Fed expects inflation to be near about its target of 2%. The unemployment rate for the current year is predicted to rise to 3.7%, up from the previous forecast of 3.6%, but remain unchanged at 3.5% for 2019 and 2020. The rate is expected to be 3.7% in 2021.

After-Effects

With decent economic growth, balanced near-term risks to economic outlook, recent strong gains in the labor market, and hope to meet inflation target, rate hike is an added advantage for banks.

Nonetheless, banks tumbled on falling of bonds yields as Powell didn’t increase the number of future rate hikes. Moreover, impacting the broader market, banking stocks went down on low 10-year U.S. Treasury yields, which restrict earnings related to net interest margin for banks.

"The main thing where we might need to move along a little bit quicker [on monetary policy tightening] is if inflation surprises to the upside. We don't see that," Powell noted further.

Notably, following the announcement, among other Wall Street biggies, shares of PNC Financial, Wells Fargo, Citigroup and BofA, all Zacks #3 (Hold) Ranked players, slipped 1.61%, 1.97%, 1.44% and 1.76%, respectively. You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

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