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Stock Analyst Update

Fed Takes Its Time in Light of Low Inflation

We think bank stock prices are priced in to higher interest rates, with Wells Fargo offering a better value.

Mentioned:

The Federal Reserve’s Open Market Committee (FOMC) once again chose to maintain the target range for the federal-funds rate at 1.0% to 1.25%, despite growth in both household spending and business investment, as inflation measures remain below its 2% target.

This action is consistent with our thesis that yield curve normalization will continue at a relatively modest pace due to a combination of trends in demographics, employment conditions, and credit demand. As long as inflation remains low, the Federal Reserve could choose to raise rates but does not need to raise rates--an important distinction, in our view. Indeed, the latest statement reveals that the FOMC expects short-term rates to “remain, for some time, below levels that are expected to prevail in the longer run.”

Our view has been informed by long-term rates, which also seem consistent with an extended low-rate environment. Ten-year bond rates are essentially the same as they were two years ago, despite the progress in economic measures over the past 24 months. We believe that long rates would move up more dramatically if the Fed’s current stance was too accommodative, and that current levels support our thesis that the central bank’s policy stance may be closer to neutral than many observers believe.

However, the Fed will begin the process of winding down its massive balance sheet in October. Quantitative easing has no doubt had some influence on long-term rates, and the market reaction to the upcoming reversal of policy will provide more information on the future course of rates. 

Finally, we believe bank stock prices have fully incorporated the benefits of higher interest rates, leaving little upside even if the normalization process happens much faster than we expect. We believe banks like  Wells Fargo offer better value, as the company's future depends on repair of its reputation rather than purely macro factors.

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