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Fed Meeting Critical for Bank ETFs

This article was originally published on ETFTrends.com.

Heading into this week's Federal Reserve meeting, it was widely expected that the central bank would again raise interest rates, potentially providing a lift for bank stocks and the related exchange traded funds in the process.

Bank and financial sector-related ETFs have been underperforming despite the rising interest rate environment. ETFs such as the SPDR S&P Bank ETF (KBE) have delivered mostly tepid year-to-date performances.

“Their underperformance this year has them perched at a key critical level and the next move could determine whether it's a boom or bust for the banks, says Miller Tabak equity strategist Matt Maley,” reports CNBC.

Fund managers argued that banks have already hit peak earnings, pointing to some red flags such as the U.S. Treasury curve flattening as short-term yields rise in response to U.S. rate hikes from the Federal Reserve and long-term yields dip on growth and trade concerns. The flatter yield curve would typically diminish bank profits as they try to profit on the spread – short-term rates affect a bank’s borrowing costs and long-term rates limit how much they can charge on loans.

Technical Concerns

“The KBE bank ETF, which holds Citigroup and Bank of America among others, broke below its 200-day moving average again earlier this week. It has fallen more than 2 percent since Monday,” according to CNBC.

Related: Bank, Financial Sector ETFs Could Continue to Lag Behind

The average U.S.-based fund has diminished its stake to financial companies by almost 1.1 percentage points in the second quarter to approximately 14%, the largest single-quarter reduction since at least 2013, Reuters reported. Still, higher interest rates are an important factor for banks.

“Higher rates expand banks' net interest margins, meaning they make more money on what they lend than what they pay in interest to borrow. A Fed hiking the fed funds rate again, as it's expected to do on Wednesday, would typically help banks,” reports CNBC.

Large-cap banks remain attractive as they have been investing in online platforms and mobile apps, which make the companies more appealing to young millennials and less dependent on more costly physical branches.

For more information on the financial sector, visit our financial category.