Investors hope that financial stocks will benefit from higher interest rates. But this is a difficult calculation. If the Fed is serious about aggressively tightening monetary policy, it could backfire on the big banks.
The Fed no longer expects a gradual increase in rates. Economists agree that a series of quarter-point hikes won’t cut it any further.
The Fed is lagging behind the inflation curve. It’s time for shock and awe.
After cutting rates to zero at the start of the pandemic in March 2020, the Fed held rates at that level until it finally raised them to the 0.25% to 0.5% range in March.
But according to data traded in futures on the Chicago Mercantile Exchange, investors are estimating a nearly 80 percent chance of a half-point hike at the Fed meeting in May and about a 55 percent chance of another half-point hike in June. There is even more than a 30% chance of a three-quarter point hike, ranging from 1.5% to 1.75%.
An increase in the interest rate could reduce corporate profits and lead to even more volatility in the stock market. Bank earnings could also be hit because Wall Street’s decline could potentially lead to lower demand for mergers and new share sales. The Wall Street giants receive lucrative advisory fees from deals, initial public offerings, and special purpose vehicle (SPAC) listings.
The ripple effect of higher stakes
An economic downturn driven by substantially higher rates could also hurt demand for mortgages and other consumer loans.
Mortgage rates are currently approaching 5% and could continue to rise along with long-term Treasuries. The 10-year Treasury yield rose to around 2.7% this week, the highest level since March 2019.
Thus, any increase in the rate of return on lending can be offset by a fall in lending activity. People are less likely to buy new homes in a real estate market that has already become prohibitively expensive for many Americans.
Yield curve inversion could also hurt banks. Given that rates on short-term bonds – primarily 2-year Treasury bonds – briefly exceed rates on 10-year Treasury bonds, this could also limit the profits of banks that need to pay higher short-term deposit rates. .
“The recent inversion of the curve has come into play for banking stocks with uncertainty over earnings and credit growth,” KBW managing director Christopher McGratty said in a preliminary first-quarter earnings report. He specifically noted the “risk of increasing the value of deposits.”
It also doesn’t help that an inverted yield curve tends to be a fairly reliable predictor of a possible recession. It goes without saying that banks will not do well if the economy goes into a sharp recession.
All of these fears hurt bank stocks. Investors seem to be more nervous about a possible pullback than encouraged by a potential short-term increase in lending profits.
Two exchange-traded funds holding shares in most of the leading banks, Financial Sector SPDR (XLF)
and SPDR S&P Regional Banking (CRE)
ETFs have fallen this year along with the broader market.
“Rising inflation and higher interest rates could lead to a recession in the US. The course of the pandemic may also change consumer behavior as we continue to move towards a new normal,” CFRA banking analyst Kenneth Leon said in a preliminary earnings report.
“American households could be more frugal and conservative when using their credit cards or personal loans. Uncertainty remains about the outlook for consumer and commercial lending, as well as investment banking,” he added.
Inflation could get worse before it gets better
Rising prices are still a major concern for many consumers. The US government will do it again with painful clarity next week when it releases two key inflation reports in March.
The consumer price index will be published on Tuesday morning. Economists predict that CPI figures will show prices have risen 8.3% over the past 12 months, according to Refinitiv. This will be up 7.9% year-on-year from February, already a 40-year high.
And experts don’t yet predict much relief on the horizon.
Inflationary problems are likely to worsen before prices start to decline. Stifel’s chief equities strategist Barry Bannister predicts in a recent report that annualized gains in the CPI will rise to 9% in the coming months before finally starting to decline in the third quarter.
Inflation is even more problematic at the wholesale level. The state producer price index, which measures the prices of raw materials sold to businesses, rose 10% in the 12 months ended February.
The fact that the PPI is rising even faster than the CPI may be a sign that businesses are either unable or unwilling to pass on all of their higher costs to consumers. This could hurt profit margins in the future.
Monday: inflation in China; Production in the UK
US consumer prices; income from CarMax (KMH)
US producer prices; profit from JPMorgan Chase, Delta (DAL)
Blackrock and Bed Bath and more (BBBI)
ECB interest rate decision; US Weekly Jobless Claims: US Retail Sales; US consumer sentiment (University of Michigan); income from Taiwan semiconductor (TCM)
, UnitedHealth (UNH)
, Ericsson (ERIC)
Citigroup, Wells Fargo, Morgan Stanley, Goldman Sachs, Rite of Help (GLAD)
US Bancorp, PNC, State Street and Ally Financial
Friday: Major stock and bond markets around the world closed on Good Friday