Why financials are likely to benefit from rising rates

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Financials are likely to benefit from rising rates. I expect that rates are likely to moderately rise from here and continue to increase in coming years, as the U.S. economy strengthens.

When rising rates are symptomatic of a strengthening economy, the financials sector’s performance and earnings outlook both tend to benefit as economic improvement leads to increasing demand for credit and higher yields on bank assets.

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For instance, in J.P. Morgan’s 2013 annual report, released in April, the bank’s Chief Executive Office Jamie Dimon estimated that a return to higher, and more historically normal, rates could increase net interest margin by 2.2% to 2.7%, and boost the bank’s profits by $6 billion after-tax. This represents a 25% increase over the bank’s 2013 adjusted earnings after tax.

fed funds rate

Market Realist – The graph above shows the opinions of each member of the Federal Open Market Committee (or FOMC) as to the appropriate federal funds rate in the next couple of years.

According to data by Keefe, Bruyette and Woods, the four biggest U.S. banks—Wells Fargo (WFC), Citigroup (C), Bank of America (BAC), and JP Morgan Chase (JPM)—saw an average decline of 2.6% in net interest margins in the first quarter of 2014. This is the worst showing in ten years for the banks. The end of the bond (BND) buying program of the Federal Reserve and the expected increase in rates in 2015 would help the banks increase their profitability, boosting the financial (XLF) sector.

Read on to the next part of this series to see why an increase in loan growth could help the banking sector.

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