The Federal Reserve is just days away from raising interest rates for the first time in nearly a decade. At least that is the point of view being reflected by Fed funds futures. That point of view is also being reinforced by investors' enthusiasm for financial services exchange funds, namely the ETFs that are heavy on bank stocks.
Making the case for ETFs such as the Select Sector Financial Slct Str SPDR Fd (NYSE:XLF), the largest financial services ETF, is the fact that many market observers believe the Fed will boost borrowing costs several times next year, sending the benchmark U.S. lending rate to 1.25 percent by the end of 2016.
Sector performances in the wake of the looming Fed rate hike could be different from following previous tightening cycles.
Is A Break From History Ahead?
Yet, according to Erik Oja, S&P Capital IQ bank equity analyst, this time is different. The Fed will likely start raising rates this month, in an attempt to recalibrate, not restrain. In other words, the Fed is not trying to slow down a fast-growing economy or dampen runaway inflation.
The economy is projected by Standard & Poor's Economics to grow 2.7 percent in 2016, below historical growth rates, while inflation remains well under control, due to energy price declines. This time the Fed is looking to increase rates to prevent speculative asset bubbles from developing further, said S&P Capital IQ in a note out Monday.
The research firm is bullish on the largest U.S. banks following a boost to short-term interest rates. S&P Capital IQ has four-star ratings on Dow component JPMorgan Chase & Co. (NYSE:JPM), Wells Fargo & Co (NYSE:WFC), Citigroup Inc (NYSE:C) and Bank of America Corp (NYSE:BAC). Those are four of XLF's top five holdings, and that quartet combines for about 29 percent of the ETF's weight, according to State Street data.
Regional Banks, ETFs And The Fed
As has been widely noted in the run-up to the Fed's December meeting, regional bank stocks and ETFs, such as the SPDR KBW Regional Banking (ETF) (NYSE:KRE), are seen as prime beneficiaries of higher interest rates.
Simply put, net interest margins at regional banks have been suppressed by the Fed's zero interest rate policy and reversing that policy is seen as an important catalyst in boosting profits for the banks in ETFs such as KRE.
S&P Capital IQ also highlighted the SPDR KBW Bank (ETF) (NYSE:KBE) as an ETF to watch as interest rates move higher.
According to S&P Capital IQ 's Stovall and Oja, all banks benefit from rising long-term interest rates, particularly if they climb faster than short-term rates, and lead to wider net interest spreads. This would be a positive for SPDR S&P Bank which is equally weighted and thus has as much exposure to regional banks, said the research firm.
S&P Capital has an overweight rating on KBE.
Todd Shriber owns shares of XLF.
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