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Fed Likely to Pause Rates in 2020: Bank Stocks Worth Buying?

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The Federal Reserve (Fed) announced no change in interest rates at the Federal Open Market Committee (FOMC) Meeting, Wednesday, under chairman Jerome Powell. The benchmark federal funds rate, thus, remained unchanged at 1.50-1.75%.

The rate was reduced to this level by a quarter-point cut in October, third time this year, to counter the adverse impact of trade conflict and a global downturn. Earlier, the central bank had slashed rates in July and September.

Further, pause on rate at the current level throughout 2020, the election year, was signalled in the meeting. The Fed’s decision of keeping the rates unchanged was supported by the strengthening economy, optimism on reaching the inflation target and impressive labor-market gains.

The move was in sync with expectations and was cheered by investors. The major exchanges — S&P 500, Nasdaq and the Dow — all ended the day in green.

Future Moves

The Fed might plan for extended pause on interest rates based on the U.S. economy movements. Notably, 13 of the 17 members of the FOMC policy-setting committee are of the opinion to keep rates unchanged in 2020, while remaining anticipate rate to rise by one notch.

However, Powell believes rates do not need to rise in the near term. Further, based on very low levels of unemployment for an extended period of time, the Fed can keep rates on hold which will not impact inflation. Notably, overall inflation has remained below the Fed's 2% target range.

Since the central bank’s meeting in October, the committee is of the opinion that monetary policy is in a "good place" and is expected not to change unless there is some "material" change.

“Our economic outlook remains a favorable one despite global developments and ongoing risks,” Powell told a press conference in Washington following the decision. “As long as incoming information about the economy remains broadly consistent with this outlook, the current stance of monetary policy likely will remain appropriate,” he further added.

Per Powell, slow global growth and persistent trade uncertainties are two fears for the U.S. economy. For this year, outlook for the U.S. economy has been reaffirmed, which is expected to increase at 2.2% and then slow down to 2% in 2020.

Though Powell is not in the favor of adjusting the monetary policy to offset short-term market volatility due to ongoing trade wars, he said consummating trade deals with China, along with Mexico and Canada would "remove uncertainty and be a positive for our economy."

The U.S. economy has been acknowledged as a "star performer" by Powell and he expects strong consumer spending and steady job growth to further enhance the same. Notably, following November's above-expectations job report, the unemployment rate is anticipated to be slightly lower this year at 3.6%, down from the 3.7% predicted in September.

Where do Banks Stand Now?

Banks thrive in the rising rate environment. Three interest-rate cuts this year have put banks in a disadvantageous position. Almost all banks, big and small, including JPMorgan JPM, Bank of America BAC, PNC Financial PNC and Zions Bancorporation (ZION - Free Report) were adversely impacted by lower interest rates.

Banks seek to borrow money at short-term rates and lend at long-term rates. As interest rates decline, the companies will earn less on lending. This compresses net interest margin (NIM) — the main indicator of a bank’s profitability.

Further, banks earn net interest income (NII) by charging borrowers higher long-term interest rates, while doling out smaller interest rates to depositors. Therefore, when the spreads between short-and long-term rates narrows, growth in banks’ NII get hampered.

Notably, banks have been warning investors of a disappointing NII and NIM growth picture for 2019. Nonetheless, a pause signal from the central bank is expected to go in banks’ favor, with hold strategy expected in the near term.

Additionally, banks are undertaking measures, including technological advancements, opportunistic acquisitions and cost-savings initiatives. These efforts, along with conservative lending policy and strong balance sheet, will definitely help banks tide over difficult times.

All the above-mentioned banks carry 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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