The Federal Reserve has raised the interest rates by 50 basis points. The Fed fund rates now stand in the 4.25% to 4.50% range, the highest since December 2007. This was expected. But what wasn’t expected by the market participants was the central bank asserting more tightening in 2023 while signaling a rise in the unemployment rate and a near stalling of economic growth.
The Fed Chair Jerome Powell, at the press conference, following the conclusion of the two-day FOMC meeting, said, “We still have some ways to go.” He further added, ““I wouldn’t see us considering rate cuts until the committee is confident that inflation is moving down to 2% in a sustained way. Restoring price stability will likely require maintaining a restrictive policy stance for some time.”
The Fed officials now anticipate the interest rates to reach 5.1% by 2023-end (up from the previously projected 4.6% in September) before coming down to 4.1% and 3.1% by 2024 and 2025, respectively. As interest income constitutes a major portion of banks’ revenues, higher interest rates, along with decent loan demand, will offer support. Hence, banks like
JPMorgan
JPM
,
Bank of America
BAC
,
Huntington Bancshares
HBAN
,
BOK Financial Corporation
BOKF
and
Zions Bancorporation
ZION
are expected to witness solid top-line improvement.
When the Fed cut short-term interest rates to near-zero in March 2020 amid the pandemic, banks witnessed net interest margin (NIM) compression. Now, with the central bank raising rates, banks including JPM, BAC, HBAN, ZION and BOKF are expected to continue recording an increase in the NIM going forward.
Despite this favorable development, there is a cause for concern for banks as the Fed offered a very grim economic picture while
reiterating
its aggressive stance to bring inflation down. The inflation is cooling down, with the November reading of 7.1% marking a second straight monthly fall.
But the path to bring down inflation to its target will inflict some pain on the economy. Per the Fed’s latest
Summary of Economic Projections
, the U.S. economy will be slowing down considerably next year, with just 0.5% growth compared with the previous expectation of 1.2% growth.
Banks’ financials are tied to the health of the economy. As the economy slows down and demand for loans wanes, banks’ earnings are likely to be adversely impacted. This will present a huge challenge for banks like JPMorgan, Bank of America, Huntington Bancshares, BOK Financial and Zions.
So, for banks, the situation will be like a double-edged sword. But this shouldn’t drive the investors away from bank stocks. Over the past decade, several operating efficiency-strengthening initiatives and stringent regulatory capital requirements have made banks fundamentally stronger. Banks have moved away from risky operations and are now focused on bolstering core businesses.
A conservative lending policy, higher interest rates and a strong balance sheet position will keep supporting banks. Global diversification and changing the mix to focus more on other revenue sources, along with technological advancements, will continue aiding financials.
Undoubtedly, the operating environment will get tough for banks in 2023. But investors must not shy away from investing in banking stocks that are fundamentally strong and have long-term prospects. At the same time, they must keep their eyes open for any near-term headwinds.
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