Should You Buy Bank ETFs Ahead Of The Fed Meeting?

All eyes are currently on the crucial two-day FOMC meeting slated to start today. The central bank is expected to hold rates steady but start shrinking its massive $4.5 trillion balance sheet, which is mostly composed of Treasuries and mortgage-backed securities purchased until 2014 since recession.

Additionally, investors will be watching Fed’s future course of action on rates hike as the fastest pace of increase in August inflation since spring increased the odds of a rate hike in December. The market is now expecting more than a 50% chance of a December rate hike, up from about 30% chance one week ago, according to CME Group’s FedWatch Tool.

Unwinding of Balance Sheet: Boost to Banks

In June, the Fed laid out plans of reducing bond holdings. So long, it has reinvested the entire proceeds it got from bonds. Now, the Fed will use a cap system every month to execute its roll off plans and reinvest the rest. The central bank has set a roll off target of $10 billion that will increase quarterly until it reaches $50 billion ($30 billion for Treasuries and $20 billion for mortgage-backed securities) a month. The process is likely to continue until the balance sheet reaches about $2-$2.5 trillion.

The decision to reverse the Quantitate Easing policy is a step toward monetary tightening and will lower demand for the currency, leaving an adverse impact on global liquidity. The historic move will push long-term rates higher relative to short-term rates and in turn benefit bank stocks. This is because banks 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.

Given this, we have highlighted bank ETFs that would likely gain from the Fed’s likely move.

SPDR S&P Bank ETF (KBE - Free Report)

This fund offers equal weight exposure to 73 banking stocks by tracking the S&P Banks Select Industry Index. Regional banks dominate the portfolio with three-fourth of share while diversified banks, thrifts & mortgage finance, asset management & custody banks and other diversified financial services take the remainder. It has amassed $3.2 billion in its asset base while trades in heavy volume of 2.4 million shares a day on average. The product has gained 3.3% in a week ahead of the Fed meeting and has a Zacks ETF Rank #3 (Hold).

PowerShares KBW Bank Portfolio (KBWB - Free Report)

This fund provides exposure to 24 leading national money centers and regional banks or thrifts by tracking the KBW Bank Index. It is concentrated on the top five firms that make up for at least 8% share each. The fund has managed $837.7 million in its asset base and trades in solid volume of 454,000 shares per day on average. Expense ratio comes in at 0.35%. KBWB added 2.8% in a week and has a Zacks ETF Rank #3.

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Disclosure: contains statements and statistics that have been obtained from sources believed to be reliable but are not guaranteed as to accuracy or completeness. References to any specific ...

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