Wall Street's banks may become the biggest victims of the Fed’s growing dovishness. Big bank stocks slumped the most in two months on Wednesday after Fed Chair Jerome Powell left interest rates unchanged and signaled to keep it that way until at least the end of the year. The news comes at a time when bank stocks were making a strong rebound following last year’s miserable performance. And the Fed's move could squeeze bank profit growth, reining in their shares.
Big banks, including JPMorgan Chase & Co. (JPM), Citigroup Inc. (C), Goldman Sachs Group Inc. (GS), Morgan Stanley (MS) and Bank of America Corp. (BAC), were down for a second day on Thursday as of mid-day.
These financial giants along with many smaller bank stocks will now have to contend with a year of low rates and a flatter yield curve, which doesn’t bode well for profitability. “Lower interest rates and the flattening of the curve does hurt banks in terms of their net interest margins and their profitability on new loans,” Paul Eitelman, senior investment strategist at Russell Investments, said in a detailed story in Bloomberg.
The 2019 Rebound in Bank Stocks
(KBW Nasdaq Bank Index performance)
- 18% in 2018
+ 13% YTD
Source: Yahoo! Finance, CNN Money
What it Means for Investors
A report published by Goldman Sachs days prior to the Fed’s decision showed expectations that the financial sector would lead earnings per share (EPS) growth in 2019. The firm’s top-down estimates for financials’ earnings growth in 2019 was 8%, while the report showed consensus bottom-up estimates of 9% EPS growth for financials and just 3% for the S&P 500 in 2019.
That outlook could change as yields on 10-year Treasuries slumped to their lowest level in more than a year after the Fed’s dovish position reflected concerns that economic growth may be slowing. Slower economic growth is not good for loan demand and credit quality. Perhaps more important, a flattening yield curve with lower rates on longer maturity debt while rates on shorter maturity debt remained unchanged pinches bank profit margins.
“This kind of sucks for the yield curve and probably isn’t great for banks,” Yousef Abbasi, director of U.S. institutional equities and global market strategist at INTL FCStone, told Bloomberg. “Clearly they kind of threw their hands up on this one.”
While slower economic growth and a flatter yield curve will weigh on bank profits in the near term, some believe that the banking sector has been “a forgotten sector.” Banks are carrying much less risk and, after last year’s rout, are positioned to breakout at some point. “I’m positive on the space long term. I’m very surprised that it has taken this long but if we’re taking a long-term perspective for our clients, I’m fine waiting 18 months for it to bounce back,” Michael Bapis, managing director of Vios Advisors at Rockefeller Capital Management, told CNBC.