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Fed Likely to Pursue Ultra-Hawkish Policies in July: 5 Picks

·6 min read

The Fed will conduct its next FOMC meeting from Jul 26-27, for which market participants are keenly waiting. After hiking the benchmark interest rate by 25, 50 and 75 basis points in last three FOMC meetings in March, May and June, respectively, the central bank has indicated that another 50 to 75 basis points rate hike is almost certain in July.

Investors are expecting the continuation of tighter monetary policies after strong job additions in June. Per the CME FedWatch data released on Jul 11, there is 90.6% probability that the Fed will hike the rate by 75 basis points in July. Moreover, 9.4% of the respondents are expecting a 1% hike in the benchmark lending rate in the July FOMC.

The Fed terminated the $120 billion per month bond-buy program in March and started shrinking its $9 trillion balance sheet systematically from June. Consequently, the market risk-free rate has spiked as the yield on the 10-year U.S. Treasury Note is currently hovering around 3%.

A higher interest rate is likely to benefit the financial sector, especially banks and insurance companies. At this stage, it will be prudent to invest in financial stocks with a favorable Zacks Rank. Here are five such stocks —  JPMorgan Chase & Co. JPM, M&T Bank Corp. MTB, Raymond James Financial Inc. RJF, Arch Capital Group Ltd. ACGL and Everest Re Group Ltd. RE.

Financial Sector Likely to Gain

A hike in interest rate will raise the cost of funds, which would enable the financial sector, especially banks, to widen the spread between longer-term assets, such as loans, with shorter-term liabilities, thus boosting profits margins.

Banks have been witnessing a contraction in net interest margins (an important barometer to gauge banks’ financial performance) owing to near-zero rates. This is also hurting their top-line growth.

Consequently, as the Fed has started aggressively hiking interest rates, pressure on margins will gradually alleviate and support banks’ net interest income. Despite the diversification of revenue streams, banks earn a major portion of their revenues from interest income.

A major part of the financial sector is the insurance industry. It consists of life insurers, property and casualty insurers, accident and health insurers, multiline insurers, and insurance brokerage firms.

Insurance providers are generally compelled to hold lots of long-term safe bonds to back the policies that are written. A higher interest rate will benefit insurance companies. The spread between the longer-term assets and shorter-term liabilities will increase the spread of insurers. Moreover, the insurance industry's profitability has risen historically during the period of rising interest rates.

Our Top Picks

We have narrowed our search to five financial stocks with strong long-term growth potential. These stocks have seen positive earnings estimate revisions for the current year in the last 60 days. Each of our picks carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The chart below shows the price performance of our five picks year to date.

Zacks Investment Research
Zacks Investment Research

Image Source: Zacks Investment Research

M&T Bank provide banking services that offers deposits, business loans and leases, and credit cards and cash management, payroll and letters of credit services to small businesses and professionals. Organic growth, driven by higher fee income, loans and deposits, will likely increase MTB’s revenues.

M&T Bank is growing inorganically backed by a sound liquidity position. The acquisition of People's United Financial is expected to be accretive to its earnings. Capital deployment activities seem sustainable, given its favorable debt/equity ratio.

M&T Bank has an expected earnings growth rate of 7.4% for the current year. The Zacks Consensus Estimate for current-year earnings has improved 0.9% over the last 7 days. MTB has a current dividend yield of 3%.

JPMorgan Chase will benefit from higher interest rates and rising loan demand. Opening new branches, strategic acquisitions/investments, global expansion and digitization, and a decent investment banking pipeline are likely to keep aiding JPM’s top line. Also, JPMorgan Chase’s steady capital deployments look sustainable and would enhance shareholder value.

JPMorgan Chase has an expected earnings growth rate of 13% for next year. The Zacks Consensus Estimate for current-year earnings has improved 0.8% over the last 60 days. JPM has a current dividend yield of 3.5%.

Raymond James is performing relatively well in an intensely competitive environment. Supported by a solid balance sheet position, RJF has been undertaking strategic acquisitions. These efforts are expected to help Raymond James enhance its service offerings, diversify revenues and expand its footprint globally.

Also, RJF’s efficient capital deployment activities seem sustainable on a solid liquidity position, through which the company will likely continue to enhance shareholder value.

Raymond James has an expected earnings growth rate of 4.8% for the current year (ending September 2022). The Zacks Consensus Estimate for current-year earnings has improved 2.6% over the last 60 days. RJF has a current dividend yield of 1.5%.

Everest Re’s global presence, product diversification and capital adequacy bode well. Higher premiums earned by the Insurance segment will likely improve the expense and loss ratio. The Reinsurance segment of RE remains well-poised for leveraging opportunities, stemming from the continued disruption and evolution of the reinsurance market.

Strong capital position, with sufficient cash generation capabilities support effective capital deployment. Everest RE is lowering exposure to areas not meeting the right risk-return profile, building a portfolio with a mix of product lines, better rate adequacy and higher long-term margins and repositioning its portfolio by moving up fixed income credit quality.

Everest RE has an expected earnings growth rate of 20.1% for the current year. The Zacks Consensus Estimate for current-year earnings has improved 1.5% over the last 30 days. RE has a current dividend yield of 2.4%.

Arch Capital boasts a strong product portfolio and has been maintaining an exemplary track record of premium growth. Premiums should benefit ACGL from new business opportunities, rate increases, growth in existing accounts and growth in Australian single premium mortgage insurance.

This apart, Arch Capital has been diversifying its Mortgage Insurance business via strategic acquisitions that complement the strength in the specialty insurance and reinsurance businesses. A solid capital position shields ACGL from market volatility. It effectively deploys capital to pursue growth initiatives. Strategic buyouts strengthen the portfolio of Arch Capital and offer geographic diversification.

ACGL has an expected earnings growth rate of 21% for the current year. The Zacks Consensus Estimate for current-year earnings has improved 0.2% over the last 7 days.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
JPMorgan Chase & Co. (JPM) : Free Stock Analysis Report
M&T Bank Corporation (MTB) : Free Stock Analysis Report
Everest Re Group, Ltd. (RE) : Free Stock Analysis Report
Raymond James Financial, Inc. (RJF) : Free Stock Analysis Report
Arch Capital Group Ltd. (ACGL) : Free Stock Analysis Report
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