The Federal Reserve on Wednesday kept interest rates unchanged at 0.00-0.25%, with indications that it will be at the same level through 2022. Nevertheless, the central bank projects economic growth for the next two years.
The post-meeting statement noted, “The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”
Also, the Fed Chair Jerome Powell at the post-FOMC meeting virtual press conference said that the central bank will do "whatever we can and for as long as it takes" to minimize the damage to the economy. In order to continue supporting the U.S. economy, the Fed plans to continue purchasing bonds and is “committed to using the full range of tools to support the economy.”
The central bank provided a grim outlook for this year. It now projects GDP to contract 6.5% this year (against growth of 2% estimated in December 2019) due to coronavirus-induced economic slowdown faced by the country. Further, unemployment rate and inflation will be 9.3% and a mere 0.8% (way below the central bank’s target of 2%), respectively. For 2021 and 2022, the central bank projects GDP growth rate of 5% and 3.5%, respectively.
Where do Bank Stocks Stand Now?
Powell said, “We're not even thinking about thinking about raising rates.” This came as a big blow to bank stocks.
Following these developments, 10-year Treasury yields witnessed the biggest daily drop in almost two months. Also, the finance sector indexes like KBW Nasdaq Bank Index, SPDR KBW Regional Banking KRE and S&P Banks Select Industry Index plunged more than 6%, with bank stocks including JPMorgan JPM, Morgan Stanley, Citigroup C, CIT Group, Regions Financial RF, Goldman Sachs GS and Bank of America BAC ending the day in red.
Decline in treasury yields hurts banks’ profitability as narrower spread between long-term and short-term rates hampers net interest margin growth. Also, with the economic slowdown, demand for loans will likely remain muted. Thus, banks’ net interest income (NII) growth will likely be muted as well.
The near-zero interest rates will hurt banks’ net interest margins (NIM). Banks earn net interest income by charging borrowers higher long-term interest rates, while doling out smaller interest rates to depositors. This results in an improvement in NIM. However, with growth in NII expected to get hampered, NIM will continue to contract.
With banks already facing higher delinquency rates mainly due to the virus outbreak, which hit all sectors hard, the Fed’s accommodative stance is a bad news.
Banks’ financials that depend on the health of the economy will be hurt. Therefore, banks’ earnings, which remained at record levels amid improving economy and higher interest rates, are likely to be adversely impacted this year.
Should You Stay Away From Banks?
Over the past decade, several operating efficiency strengthening measures and stringent regulatory capital requirements have made banks fundamentally stronger. Banks have moved away from risky operations and are now focused on strengthening core businesses.
A conservative lending policy, higher interest rates, strong balance sheet position and improving economy support the banks’ performance. Last year was one of the strongest growth years for banks since the financial crisis, despite the Fed cutting rates thrice to support the economy during the U.S.-China trade war.
Global diversification and changing mix to focus more on other revenue sources, along with technological upgrades are expected to continue supporting banks’ profitability. Also, there has been a rise in consolidation efforts among the industry players.
No doubt, near-zero rates are here to stay. But you can bet on banking stocks that are fundamentally strong and have long-term prospects. At the same time, keep your eyes open to near-term factors as well.
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Click to get this free report JPMorgan Chase Co. (JPM) : Free Stock Analysis Report Regions Financial Corporation (RF) : Free Stock Analysis Report The Goldman Sachs Group, Inc. (GS) : Free Stock Analysis Report Bank of America Corporation (BAC) : Free Stock Analysis Report Citigroup Inc. (C) : Free Stock Analysis Report SPDR SP Regional Banking ETF (KRE): ETF Research Reports To read this article on Zacks.com click here. Zacks Investment Research