The November CPI reading of 6.8% inflation, the largest year-over-year increase in 39 years, appeared to be the straw that broke the “transitory” camel’s back at the Federal Reserve, suggests Jason Clark, money manager and contributing editor to The Prudent Speculator.
Indeed, in mid-December, Jerome Powell & Co. elected to double the pace of the tapering of its bond purchase program (from $15 billion to $30 billion per month) and suggested that there could be as many as three hikes in the Federal Funds rate in 2022.
Apart from potentially higher longer-duration rates, we think the hawkish adjustment by the nation’s monetary authority ought to boost loan growth (which has been lacking for much of the pandemic), as consumers and businesses look to lock in loans before rates rise.
This should benefit regional banks like Citizens Financial (CFG) and Bank OZK (OZK) that derive a significant portion of their income from the spread on interest earned from loans versus the costs paid on deposits.
True, increases in short-term rates could affect funding costs, but we note that many (if not most) banks in our universe boast significant deposit balances relative to the loans on their books, so they have less of a need to aggressively raise incentives to attract more money.
Not to be overlooked is that most bank balance sheets are in fantastic shape, with plenty of loan-loss reserves and low levels of non-performing assets. In addition, the large money-center banks with diversified revenue streams, including Bank of America (BAC), JPMorgan (JPM) and Citigroup (C), also have reach extending to corporate and municipal issuers looking to finance investment at relatively cheaper rates.
To be sure, volatility in the U.S. Treasury yield curve will often drive daily movements of stocks in the financial sector. Of course, the group outperformed during the last Fed Tapering cycle (2012-2014) as longer-term government bond prices fell and yields rose with Uncle Sam’s reduced buying pressure, so we do not want to forget that higher interest rates have also been a tailwind for insurance companies like Allianz (ALIZY), MetLife (MET) and Prudential Financial (PRU).
