Bank ETFs Set To Explode Higher On Fed's Hawkish View

As expected, the Fed has raised interest rates for the second time this year by 25 bps to 1.75-2%. This also marks the seventh rate hike since December 2015. The central bank signaled a hawkish outlook tweaking its language for economic growth to “rising at a solid rate" from “moderate” provided in May.

It also dropped its word "stayed low" for unemployment and “moderated” for household spending. The Fed now believes that the unemployment rate has "declined” and household spending "has picked up." All these indicate two more lift-offs that would translate into four total increases in 2018.  

The Fed Chair, Jerome Powell, stated that the economy had strengthened significantly since the 2008 financial crisis and is approaching a “normal” level that could allow the Fed to soon step back and play less of a hands-on role in encouraging economic activity. This reflects optimism about the health of the economy and a faster-than-expected rates hike that would shoot up the borrowing cost for cars, home mortgages and credit cards over the next year.

The Fed also raised its forecast for GDP growth to 2.8% for this year compared with the previous expectation of 2.7% and lowered the expectation for unemployment rate to 3.6% from 3.8%. Additionally, inflation forecast rose to 2.1% for this year through 2021.

Coming to unwinding of the balance sheet, the Fed will increase the monthly cap of its $4.4 trillion balance sheet shrinkage by $10 billion per month beginning in July, bringing the total monthly reduction of its balance sheet to $40 billion from $30 billion as of June. This move will continue to push long-term rates higher.

A Boon for Banks

A rising rate environment is highly beneficial for cyclical sectors like financial, technology industrials and consumer discretionary but banks are in the most advantageous position. This is because they seek to borrow money at short-term rates and lend at long-term rates. With the steep rise in long-term interest rates, banks would be able to earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits.

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