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How Monetary Policy and the Yield Curve Are Shaping Up in 2018

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Further rate hikes

The Federal Reserve is expected to increase the Fed funds rate two more times in 2018. The yield curve is flattening, indicating a smaller difference between short-term and long-term interest rates. This has happened because the Fed has pushed for higher short-term rates with no major uptick in long-term rates. A flattening yield curve is a cause for concern, as it indicates weaker expectations from long-term equity and debt assets.

The rate hike expectations have resulted in withdrawal from debt offerings by investors, resulting in lower underwriting and trading activity.

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Credit offtake

Banks (XLF) require a healthy macro environment to see better lending and asset quality, investment banking, and asset management fees. With interest rates rising and lower taxes, companies can consider reducing high-cost leverage, resulting in weaker lending for credit companies and banks.

JPMorgan (JPM) and Bank of America (BAC) are among the few bankers to see strong growth in credit offtake. Citigroup (C) has also managed to see a positive loan book. However, Wells Fargo (WFC) continues to see flat or negative growth in credit offtake.

Wells Fargo managed a net interest margin (or NIM) of 2.8% in the first quarter, which was flat sequentially, reflecting the stabilizing of NIMs. Thus, any rate hike from here on might lead to weaker net interest income (or NII). The bank has managed net interest income of $12.2 billion versus $12.3 billion in the prior year on a decline in lending activity. Net income rose to $5.9 billion from $5.5 billion helped by lower taxes.

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