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Here's What Fed's Dovish Economic Stance Means for Banks

Swayta Shah
Investing in REITs and utilities - sectors gaining from a soft rate environment - makes for a smart move.

In an abrupt change in course of action, the Federal Reserve on Wednesday turned dovish and said that there will be no further interest rates hikes this year. The interest rate remains 2.25-2.50%. The central bank had predicted two rate hikes for 2019 in its December forecast.

In the post-meeting statement, Fed officials indicated that they will remain “patient” before undertaking any further rate hikes. Further, the statement said, “recent indicators point to slower growth of household spending and business fixed investment in the first quarter.” It also added that “overall inflation has declined” mainly due to lower energy prices.

Additionally, the Fed lowered GDP growth and inflation projections while raising the unemployment rate outlook. The officials now project GDP growth rate of 2.1% this year, down from the 2.3% estimate provided in December, with inflation reaching 1.8% (a reduction from 1.9%) and unemployment rate 3.7% (up from 3.5% previously expected).

For 2020, the central bank projects GDP growth of 1.9%, inflation of 2% and unemployment rate of 3.8%. The outlook is disappointing compared with December 2018 projections.

Impact on Bank Stocks

It seems that the U.S. economy is gradually losing momentum contrary to Fed Chairman Jerome H. Powell’s statement that the economy “is in a good place” during the news conference. The primary reasons for dismal projections are concerns over the ongoing trade war, economic slowdown in Europe and China and declining stimulus from the lower tax rates.

Following these developments, 10-year Treasury yields declined to their lowest level over the past year. Also, the majority of the finance sector indexes like KBW Nasdaq Bank Index BKX and S&P Banks Select Industry Index, and stocks including JPMorgan JPM, Citigroup C, Goldman Sachs GS and Bank of America BAC witnessed a fall.

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 economy showing signs of slowdown, demand for loans will likely remain muted. Thus, banks’ interest income growth will likely slow down as well.

Banks’ financials that depend on the health of the economy will be hurt. Therefore, banks’ earnings, which have remained at record levels amid improving economy and higher interest rates, are likely to be affected.

Nonetheless, banks’ business restructuring and streamlining efforts, conservative loan policy and focus on improving other revenue sources are expected to support financials to some extent.

Of the bank stocks mentioned above, Bank of America currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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