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Deck the Banks with Boughs of Rate Hikes: Financial ETFs Suffer

This article was originally published on ETFTrends.com.

The capital markets were hoping for doves before Christmas, but it was on Dasher, on Prancer and on with more rate hikes by the Fed on Wednesday. As such, financial exchange-traded funds (ETFs) declined on the notion that more rate hikes could hurt business in 2019.

Financial Select Sector SPDR (XLF) fell 1.25 percent, the SPDR S&P Bank ETF (KBE) dropped 2.64 percent and the  Vanguard Financials ETF (VFH) shed 1.52 percent. However, the prospect of a pause in rate hikes in 2019 could give financial ETFs hope.

"The irony is that financials didn't do well this year when rates are going up, it may be the case that financials do better in 2019 as the Fed backs off," Mike Wilson, Morgan Stanley's chief U.S. equity strategist.

The Fed didn’t pull any rabbit punches on the capital markets by raising interest rates another 25 basis points to a range of 2.25 to 2.50 on Wednesday. Following the decision, Federal Reserve Chairman Jerome Powell communicated that the central bank sees “growth moderating ahead.”

It was a good start to what could've been a more dovish tone, but Powell proceeded to take a different path.

Fed Not Feeling the Dove

Powell proceeded to sing the praises of the current economy. Backed by data showing solid growth and a robust labor market, Powell mentioned that the “U.S. economy has continued to perform well” and “signs of a more robust economy proved accurate.”

Furthermore, the Fed sees two more rate hikes in 2019, which may have been the negative catalyst that brought banks into the red zone. With the major indexes responding negatively to the mention of further rate hikes, all sectors were hoping for a more dovish Fed.

"There's a lot of nuance in the decision. I think what's pretty clear from the statement is Powell is not poised to turn sharply dovish," said Brian Dangerfield, macro strategist at NatWest Markets. "The Fed is going to be data dependent, but the data on which they are depending has not slowed dramatically."

Tight Won't Make Markets Right

The Fed Chair also made mention of reducing its balance sheet, which traders view as a tightening policy that would signal more rate hikes--something the markets don't want to hear at this point.

"It just reinforces that between the Fed hiking and shrinking its balance sheet, it's double tightening in 2019. I think it just reinforced the market did not get the dovish hike it was looking for," said Peter Boockvar, chief investment strategist at Bleakley Advisory Group.

After being up over 200 points, the Dow Jones Industrial Average proceeded to fall by over 500 points following Powell's post-rate hike press conference.

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