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What Coronavirus Induced 'Emergency' Rate Cut Means for Banks

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Coronavirus has led the Federal Reserve to cut interest rates by half a percentage point. This was the first unscheduled and biggest one-time move by the central bank since the 2008 financial crisis. Now, the benchmark interest rate is in the range of 1% to 1.25%.

In a press conference following the announcement, Fed Chairman Jerome Powell said “My colleagues and I took this action to help the U.S. economy keep strong in the face of new risks to the economic outlook. The spread of the coronavirus has brought new challenges and risks.”

While the Fed in the statement noted that “fundamentals of the U.S. economy remain strong,” this ‘emergency’ step spooked the markets. Investors saw this as an indication that the economy is likely to be more adversely impacted than previously expected.

All the three major indexes – S&P 500, Dow Jones and Nasdaq – that soared sharply on Monday following Powell’s statement indicating an appropriate action, declined almost 3% yesterday. Also, the 10-year Treasury yield fell below 1% for the first time as the investors moved toward safe havens.

This is not all. Themarket is expecting more easing later this year.Per the CME FedWatch tool, there is a 53.6% chance of another 75 basis-point cut in interest rates in April.

Also, Powell has left the doors open to further actions to support the U.S. economy. He said, “In the weeks and months ahead we will continue to closely monitor developments.”

Amid all these developments, banks, one of the biggest beneficiaries of higher rates, are likely to be adversely impacted. Notably, KBW Nasdaq Bank Index and SPDR KBW Regional Banking (KRE - Free Report) fell 4.6% and 4.2%, respectively, on Tuesday.

Travel restrictions, business shut downs and other measures taken to curb the virus spread in China (the world second largest economy) are likely to hurt global economy. Further, these are disrupting supply chains and sales generation of several global tech, auto and travel sector companies, and will likely hurt consumer spending.

Further, earlier this week, the Organization for Economic Cooperation and Development had projected that global growth could halve in case the virus outbreak continues. Thus, business investments are likely to be less and will result in lower loan demand.

Further, banks during fourth-quarter 2019 conference call had expected no change in rates while providing 2020 guidance. At that time, most banks had projected a flat to modest decline in net interest income (NII), partially offset by decent loan demand.

But now with one rate cut and more on the horizon, and less demand for loans, NII is expected to be further affected. Net interest margin – a major indicator of banks profitability – will now contract further.

Further, as the U.S. economy is being adversely impacted by coronavirus, delinquency rates are likely to rise. So, banks’ asset quality is expected to deteriorate.

Thus, investors should exercise extra caution before investing in bank stocks. Also, though all the banks big or small are likely to be adversely impacted, for major global banks like Bank of America BAC, JPMorgan JPM and Citigroup C, this could turn out to be a bigger concern. In fact, diversification could turn out to be a negative factor.

Therefore, banks with only domestic operations like Truist Financial TFC, Zions Bancorporation ZION and M&T Bank MTB could turn out to be better investing options. Still investors should check out individual company fundamentals and keep an eye on near-term concerns before taking any decision.

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