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What Fed's Lack of Action Means for U.S. Bank Stocks

One consequence of near-term rate stabilization is the need for banks to cut operational costs in order to increase earnings.

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Last week, the Federal Reserve's Federal Open Market Committee decided to maintain the benchmark federal-funds target rate at 0.25%-0.50%, which has been consistent since its increase in December. Since that move, we have seen improvement in the net interest margins of U.S. banks as they incorporated the increase into their pricing structures. Even though the yields on loans have increased at most banks, this has not damped loan demand, which continues to be solid across our coverage, at mid-single-digit growth on average. In addition, we have observed varying degrees of net interest margin expansion among banks reporting first-quarter results, largely because of increased yields.

In December, the Fed indicated that its expected target fed-funds rate would approximate 1.375% by year-end 2016 through four subsequent increases. Since then, however, the Fed has moderated its expectation to two increases approximating 0.875% by year-end. As largely reflected in the FOMC statement, we expect future increases in the fed-funds rate to be deliberate over a longer time, with the Federal Reserve's mandate for full employment and keeping inflation at 2% continuing to dictate future moves. While the rate increase has helped loan yields for banks, the signal that another rate rise is not imminent is less welcome news for U.S. banks. Most U.S. banks remain asset-sensitive in that they are able to reprice their assets (loans and securities, for example) faster than the funding for those assets (deposits and borrowings).

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Dan Werner does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.