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How the Fed’s Rate Hike Cycle Can Impact Citi and Other Banks

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Rate outlook

The Federal Reserve increased rates in June and has hinted at two more rate hikes this year. It has also given guidance of three rate hikes in 2019 and a reduced 2020 outlook to one rate hike, compared to two as indicated earlier. It has effectively shortened the rate hike cycle by one quarter, with a final count of rate hikes being same as previously announced. 

By the end of the anticipated rate cycle, the Fed funds rate can stabilize at ~3.5%–3.75%, still lower than 5.25% witnessed before the 2007 recession.

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Spreads versus credit

Banks (XLF) have benefited from this cycle, as it has helped them expand interest rate margins and spreads. However, NIMs have stabilized in recent months, mainly due to lower taxes and higher rates reducing the demand for credit. 

In the absence of major credit growth, banks are expected to offer attractive rates in order to garner balance sheet growth in core banking areas. Banks have also seen improved retail credit growth. However, as rates become steeper, the demand can become weaker in the upcoming quarters.

Middle-market lenders, including Prospect Capital (PSEC), are facing the pressure of leverage and lower credit growth. The outlook for Tier 2 lenders is expected to remain weak for the next couple of years.

Global reversal

The reversing of monetary policy has begun globally, with the ECB announcing the cancellation of its buyback program by December. Only the Japanese Central Bank is expected to give a hawkish outlook in 2018.

Global bankers such as Bank of America (BAC), JPMorgan Chase (JPM), and Citigroup (C) can garner credit growth through retail, asset management, and middle-market offerings outside the US.

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