Banks Rejoice as Federal Reserve Hikes Rate to 1.00-1.25%

On Wednesday, at the Federal Open Market Committee (FOMC) Meeting, the Federal Reserve announced the second rate hike of 2017. The Fed plans tightening of monetary policy to continue, with declining unemployment despite increasing worries over weak inflation.

The benchmark federal funds rate has been hiked to 1.00–1.25%, from 0.75–1.0% raised in Mar 2017. Notably, this is the fourth raise in interest rates since the 2008 financial crisis, which led the Fed to lower rates to near zero.

Fed policymakers continued with their projections of one more rate increase in 2017, followed by three hikes each in 2018 and 2019. Its long-run rate is projected to be 2.9%, down marginally from the previous forecast of 3.0%. The Fed maintained its expectation of rate increases to be "gradual."

The interest rates hike will ease some pressure on net interest margin NIM – a key source of banks' earnings. Also, banks will earn more from the money that they need to keep at the Fed compared with low income from this source in the low-rate environment that has prevailed since the last financial meltdown.  

Further, on the improving U.S. economy, the Fed plans to shrink its portfolio of treasury bonds and mortgage-backed securities worth $4.5 trillion, purchased during the 2007–2009 financial crisis. Precisely, the Fed aims to reduce fixed amount of assets on a monthly basis. Initially, the amount is expected to be $10 billion, including $6 billion from Treasuries and $4 billion from mortgage-backed securities (MBS).

In addition, the capped amount will increase once in three months by $6 billion for Treasuries and $4 billion for MBS to achieve the target of $30 billion and $20 billion, respectively.

In a press conference, after the rate hike was announced, Fed Chair Janet Yellen said that the unwinding plan could be put into effect "relatively soon" if the economy evolves as the central bank expects.

"Near-term risks to the economic outlook appear roughly balanced, but the committee is monitoring inflation developments closely," the Federal Open Market Committee said in a statement on Wednesday, following a two-day meeting in Washington. "The committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated," stated the committee.

With decent economic growth, recent strong gains in the labor market, including a May jobs report depicting unemployment down to 4.3%, and inflation target anticipated to return to the Fed's 2% target, rate hike is an added advantage. However, there are temporary concerns over the weak inflation.

"Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the committee's 2 percent objective over the medium term," the committees' statement noted.

Following the interest rate hike announcement, most Wall Street biggies, including U.S. Bancorp USB, The PNC Financial Services Group, Inc. PNC, Citigroup Inc. C and Bank of America Corporation BAC, increased their prime lending rate to 4.25%, effective Jun 15, 2017.

Notably, PNC Financial, with a Zacks Rank #2 (Buy), and BofA, with a Zacks Rank #3 (Hold), reflected investors' optimism, with shares rising 6.0% and 7.5%, respectively, year to date. You can see the complete list of today's Zacks #1 (Strong Buy) Rank stocks here.

Additionally, U.S. Bancorp and Citigroup's shares rose 2.8% and 8.9%, respectively, depicting positivity on future prospects.

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