Wall Street Week Ahead Investors are sheltering in US regional banks as Fed hikes loom

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Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S. January 6, 2022. REUTERS/Brendan McDermid

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NEW YORK, Jan 21 (Reuters) – Expectations of rising interest rates are bolstering shares in regional banks as a plunge in tech stocks prompts investors to seek assets that could thrive amid higher yields and tighter Federal Reserve policy.

The SPDR S&P Regional Banking ETF (KRE.P) was up 2% year-to-date on Friday afternoon, compared to a 6.6% decline in the S&P 500. The gains of some individual bank stocks have been even more striking: Shares of Citizens Financial Group Inc (CFG.N) are up 8.4% year-to-date, while shares of KeyCorp (KEY.N) are up nearly 9%.

Regional banks derive a significant portion of their income from net interest margins, making them more attractive as investors increasingly expect the Fed to hike rates more aggressively this year to control inflation. The central bank meets next week and is expected to hike interest rates as early as March. L4N2TZ0GWL4N2TQ2J1

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Government bond yields have risen on anticipation of tighter policy, with benchmark 10-year government bond yields up 40 basis points from recent lows.

At the same time, some investors expect the expanding U.S. economy and reduced fiscal stimulus to boost credit growth, which will help regional banks post full-year 2021 earnings growth of 70.1%, the seventh-fastest among the 126 subsectors in the S&P 500 Goldman Sachs.

“If you want to take advantage of the yield curve steepening, the best way to do that is through regional banks,” said Moustapha Mounah, deputy portfolio manager at James Investment, which has increased its stake in companies like SVB Financial Group.

Although investors expect regional banks to generally benefit from rate hikes, the pace at which the Fed tightens monetary policy could be crucial. Too steep a trajectory of rate hikes could hamper economic growth and eventually hurt banks’ profits, Mounah said, although such an outcome isn’t his baseline forecast.

Fed funds futures traders are fully pricing in a 25 basis point hike in March, in addition to three more rate hikes by the end of the year.

With next week’s Fed meeting concluding on Wednesday, investors are awaiting earnings from Zions Bancorp (ZION.O), which is expected to release its latest quarterly earnings results on Monday, followed by First Bancorp (FBNC.O) on Tuesday and United Bankshares Inc (UBSI.O) and Merchants Bancorp (MBIN.O) on Wednesday.

The pace of Federal Reserve rate hikes will directly impact the sector’s earnings, said Gary Tenner, an analyst at DA Davidson & Co. Tenner recently added two more expected rate hikes of 25 basis points to its valuation models for regional banks, bringing its total to four by the end of 2023, he said.

“The impact of higher interest rates is potentially more positive for valuations and returns for regional banks” than for so-called universal banks, which also have investment banking revenues, he said. Banks in the S&P 500 (.SPXBK) are up 0.4% so far in 2022.

Aside from a too-rapid pace of rate hikes, regional bank stocks could suffer if a stock sell-off that has already pushed the Nasdaq into correction territory accelerates further, raising expectations that the Fed will hike rates more slowly to avoid destabilizing markets . L1N2TZ2JG

“There’s still this debate in the stock price about how much and how fast the Fed is going to hike. If the Fed steps down, the rally we’ve seen here could slow down,” said Steve Comery, research analyst at GAMCO Investors. L1N2TZ2JG

Brady Gailey, a managing director at Keefe, Bruyette & Woods, believes that even two or three rate hikes would be enough for the sector to post above-average earnings growth as credit growth accelerates. He upgraded the regional banking sector to overweight in September.

“They’re likely to be a big beneficiary of higher interest rates, but there are other fundamentals in favor of the sector,” he said.

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reporting by David Randall; Edited by Ira Iosebashvili and Cynthia Osterman

Our standards: The Thomson Reuters Trust Principles.

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