What's in Store for Banks as Fed Signals More Rate Hikes, Slowdown?

In an unprecedented but unsurprising move, the Federal Reserve raised the interest rates by 75 basis points for the third consecutive time. Thus, the Fed fund rates now stand in the 3.0% to 3.25% range, the highest since 2008.

Further, the central bank reiterated its aggressive stance to bring inflation down to its goal of 2%. The inflation number was quite high at 8.3% for August. The Fed Chair Jerome Powell, at the press conference, following the conclusion of the two-day FOMC meeting, said, “we are focused on... getting inflation back down to 2%. We can't fail to do that. I mean, if we were to fail to do that, that would be the thing that would be most painful for the people that we serve. So, for now, that has to be our overarching focus.”

With this, the Fed officials now anticipate the interest rates to reach 4.4% by 2022-end (up from the June projection of 3.4%) and 4.6% by next year's end (up from the 3.8% projection). 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 impressive top-line growth.

When the Fed cut short-term interest rates to near-zero in March 2020 amid the pandemic, banks faced net interest margin (NIM) compression. Now, with the central bank raising rates, NIM is expected to witness further improvement. Even in the first half of 2022, banks including JPM, BAC, HBAN, ZION and BOKF recorded an increase in the NIM.

Despite this favorable development, there is a bit of concern for banks as the Fed provided a very grim economic picture. Powell noted that achieving a soft landing will be “very challenging.” Per the Fed’s latest Summary of Economic Projections, the U.S. economy will be slowing down this year, with just 0.2% growth compared with the previous expectation of 1.7% growth.

Thus, this will present a daunting challenge for banks like JPMorgan, Bank of America, Huntington Bancshares, BOK Financial and Zions. Banks’ financials are tied to the health of the economy. As the economy slows down and demand for loans gradually wanes, banks’ earnings are likely to be adversely impacted to some extent.

Hence, the situation for banks 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 efforts 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 aid banks’ performance. Global diversification and changing the mix to focus more on other revenue sources, along with technological upgrades, will continue supporting banks’ profitability.

Undoubtedly, the operating environment will get tough for banks in the coming days. 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 concerns.

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