In an unprecedented but unsurprising move, the Federal Reserve raised interest rates by 75 basis points for the third consecutive time. Thus, Fed funds rates are now in the range of 3.0% to 3.25%, the highest since 2008.
In addition, the central bank reiterated its aggressive stance to bring inflation back to its 2% target. The inflation number was quite high at 8.3% for August. Fed Chairman Jerome Powell speaking at the press conference following the two-day FOMC meeting said, “We are focused on … getting inflation down to 2%. We cannot not do it. I mean, if we failed to do that, that would be the most painful thing for the people we serve. So for now, that has to be our main focus.
With that, Fed officials now expect interest rates to hit 4.4% by the end of 2022 (up from the June projection of 3.4%) and 4.6% d by the end of next year (up from the projection of 3.8%). Since interest income is a large part of bank income, higher interest rates, along with decent demand for loans, will provide support. Thus, banks like JP Morgan (JPM – free report), Bank of America (BAC – free report), Huntington Bancactions (HBAN – free report), BOK Financial Corporation (BOKF – free report) and Zions Bancorporation (IF WE – Free Report) are expected to experience impressive revenue growth.
When the Fed cut short-term interest rates to near zero in March 2020 amid the pandemic, banks faced a net interest margin (NIM) squeeze. Now, with central bank rates rising, the NIM should see further improvement. Even in the first half of 2022, banks such as JPM, BAC, HBAN, ZION and BOKF recorded an increase in NIM.
Despite this favorable development, the banks are a bit worried because the Fed has provided a very bleak economic picture. Powell noted that achieving a soft landing will be “very difficult”. According to the Fed’s latest summary of economic projections, the US economy will slow this year, growing just 0.2% compared to the previous expectation of 1.7% growth.
So, this will present a daunting challenge for banks like JPMorgan, Bank of America, Huntington Bancshares, BOK Financial and Zions. Bank finances are tied to the health of the economy. As the economy slows down and the demand for loans gradually decreases, bank profits are likely to be affected to some extent.
Therefore, the situation of the banks will be like a double-edged sword. But that shouldn’t keep investors away from banking stocks.
Over the past decade, several efforts to strengthen operational efficiency and stringent regulatory capital requirements have fundamentally strengthened banks. Banks have moved away from risky operations and are now focusing on strengthening their core businesses.
A conservative credit policy, higher interest rates and a solid financial situation will contribute to the banks’ performance. Global diversification and changing the mix to focus more on other revenue streams, along with technology upgrades, will continue to support banks’ profitability.
Undoubtedly, the operating environment will get tougher for banks in the coming days. But investors should not hesitate to invest in fundamentally sound banking stocks offering long-term prospects. At the same time, they should keep their eyes peeled for any short-term concerns.
