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Fed Cuts Rates: Are Bank Stocks Still Worth Betting on?

Swayta Shah

In one of the most expected moves, the Federal Reserve has cut interest rates for the first time since 2008 at the end of two-day FOMC meeting. Now, the key interest rate stands in the 2.00-2.25% range following a cut of 25 basis points (bps).

Though the move was in sync with expectations, it was not cheered by investors. The major exchanges – S&P 500, Nasdaq and the Dow – all ended the day in red.

A slightly hawkish language was used by the officials in the statement. The FOMC statement said, “As the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.”

Later in the press conference, Chairman Jerome Powell, said, “When you think about rate-cutting cycles, they go on for a long time and the committee’s not seeing that. Not seeing us in that place. You would do that if you saw real economic weakness and you thought that the federal funds rate needed to be cut a lot. That’s not what we’re seeing.”

Notably, heading in to the meeting, federal funds futures markets projected a 79.1% chance of 25 bps rate cut and a 20.1% chance of a 50-bps cut. Therefore, fears that this could be just a one-off event and less aggressive rate cut stance seem to have sparked bearish investor sentiments.

Where Do Bank Stocks Stand Now?

Banks thrive in the rising rate environment. Hence, cut in interest rates put banks in a disadvantageous position. Almost all the banks, big and small, including JPMorgan JPM, Bank of America BAC, PNC Financial PNC and Zions Bancorporation ZION will be 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, they will earn less on lending. This compresses net interest margin (NIM) — the main indicator of a bank’s profitability.Also, yield curve inversion, (which has already occurred a few times over the past six months) seen as a warning of an impending economic slowdown or even recession, has been hurting banks’ NIM growth.

Further, banks earn net interest income (NII) by charging borrowers higher long-term interest rates while doling out smaller interest rates to depositors. As the yield curve inverts and the spreads between short-and long-term rates narrows, growth in banks’ NII will be hampered.

These disappointing trends have already been witnessed by several banks in second-quarter 2019. Further, big bankshave warned of a dismal NII and NIM growth picture for 2019. (Read more: Big Banks Q2 Earnings Scorecard: What Investors Need to Know)

Other matters, which were the central bank’s concern while announcing rate cut, including global economic slowdown and trade war, have been hurting business sentiments across industries. This is likely to have an adverse impact on loan demand, and hamper banks’ NII growth.

Nonetheless, the U.S. economy continues to be robust. Thus, banks’ financials, which depend on the health of the economy, will get some support.

Big banks are likely to be able to prevail over this challenging environment, given their global operations and diversified revenue streams.

For smaller domestic banks, including Commerce Bancshares, Inc. CBSH, Huntington Bancshares HBAN, Zions and Cullen/Frost Bankers, Inc. CFR, the current situation will be a bit tricky to overcome. Nonetheless, a strong domestic economy, conservative lending policy, technological advancements, inorganic growth strategy, strong balance sheet and cost savings initiatives will definitely render support.

Therefore, all is not lost for bank stocks.Investors should look in to the fundamentals and then take a wise decision to earn solid returns.

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