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Are Bank Stocks Worth Buying on Rate Cut Pause, GDP Slowdown?

Swayta Shah

In order to shield the U.S. economy from the adverse impact of trade conflict and a global downturn, the Federal Reserve (as expected) announced a quarter-point cut in the interest rates. The benchmark federal funds rate now stands at 1.50% to 1.75%.

This is the third time this year that interest rates have been lowered. Earlier, the central bank had slashed rates in July and September.

Pause Signal

The Federal Open Market Committee (FOMC) statement again emphasized that the U.S. economic growth remained healthy, with “solid” job gains and household spending “rising at a strong pace.” However, the statement noted that business fixed investment and exports continued to “remain weak.”

Besides, the FOMC changed the language in its statement, replacing “act as appropriate to sustain the expansion” with “assesses the appropriate path of the target range for the federal funds rate.”

Later in the press conference, Chairman Jerome Powell, said, “We believe monetary policy is in a good place.”

He further added, “We see the current stance of monetary policy as likely to remain appropriate as long as incoming information about the economy remains broadly consistent with our outlook of moderate economic growth, a strong labor market, and inflation near our symmetric 2 percent objective.”

This, thus, indicates a pause on future tempering except for a sharp slowdown in the economy.

Powell also noted the risks associated with trade tensions and Brexit are showing signs of waning. These two were the primary reasons cited by the central bank while announcing previous two rate cuts.

Economy Losing Steam

Just hours before the rate cut announcement, the initial data released by the Commerce Department showed that economic growth has slowed down. The U.S. economy grew at the rate of 1.9% in the third quarter.

Though it topped the economists’ forecast of 1.6%, it was below the first quarter and second-quarter growth rates of 3.1% and 2%, respectively. Weakness in business investment was the primary reason for the decline, while improved consumer spending rendered some support.

Where do Banks Stand Now?

As we all know, banks thrive amid rising rate environment and strong economic growth. But at present, both seem to be going against the banks.

Interest rate cuts have placed banks in a disadvantageous position. Almost all banks, big and small, including JPMorgan JPM, Bank of America BAC, M&T Bank MTB and Zions Bancorporation ZION will be adversely impacted by lower interest rates.

The two rate cuts in the third quarter have already hurt banks’ net interest income (NII) and compressed net interest margin (NIM) — the main indicator of a bank’s profitability. This, along with soft lending scenario, mainly in the areas of commercial and industrial, and commercial real estate is expected to continue hampering banks’ financials.

Notably, banks have been warning investors of a disappointing NII and NIM growth picture for 2019. But a pause signal from the central bank is expected to go in favor of banks with no further rate cut expected in the near term.

Over the last several quarters, banks have been getting ample support from the economy, but now this also seems to be diminishing. This is likely to hurt banks’ asset quality as well.

Big banks are somewhat better positioned to overcome this challenging backdrop on the back of their global operations and diversified revenue streams. But for smaller domestic banks like Prosperity Bancshares, Inc. PB, Huntington Bancshares HBAN, Zions and Cullen/Frost Bankers, Inc. CFR, the current situation will be a bit tricky.

Nonetheless, banks are undertaking measures including technological advancements, opportunistic acquisitions and cost-savings initiatives. These efforts along with conservative lending policy and strong balance sheet will definitely help banks tide over the difficult times.

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