All eyes are currently on the crucial two-day FOMC meeting slated to start today. The central bank is expected to hold rates steady but start shrinking its massive $4.5 trillion balance sheet, which is mostly composed of Treasuries and mortgage-backed securities purchased until 2014 since recession.
Additionally, investors will be watching Fed’s future course of action on rates hike as the fastest pace of increase in August inflation since spring increased the odds of a rate hike in December. The market is now expecting more than a 50% chance of a December rate hike, up from about 30% chance one week ago, according to CME Group’s FedWatch Tool.
Unwinding of Balance Sheet: Boost to Banks
In June, the Fed laid out plans of reducing bond holdings. So long, it has reinvested the entire proceeds it got from bonds. Now, the Fed will use a cap system every month to execute its roll off plans and reinvest the rest. The central bank has set a roll off target of $10 billion that will increase quarterly until it reaches $50 billion ($30 billion for Treasuries and $20 billion for mortgage-backed securities) a month. The process is likely to continue until the balance sheet reaches about $2-$2.5 trillion.
The decision to reverse the Quantitate Easing policy is a step toward monetary tightening and will lower demand for the currency, leaving an adverse impact on global liquidity. The historic move will push long-term rates higher relative to short-term rates and in turn benefit bank stocks. This is because banks seek to borrow money at short-term rates and lend at long-term rates. With the steep rise in long-term interest rates, banks would be able to earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits.
Given this, we have highlighted bank ETFs that would likely gain from the Fed’s likely move.
SPDR S&P Bank ETF (NYSEARCA:KBE) — This fund offers equal weight exposure to 73 banking stocks by tracking the S&P Banks Select Industry Index. Regional banks dominate the portfolio with three-fourth of share while diversified banks, thrifts & mortgage finance, asset management & custody banks and other diversified financial services take the remainder.
KBE has amassed $3.2 billion in its asset base while trades in heavy volume of 2.4 million shares a day on average. The product has gained 3.3% in a week ahead of the Fed meeting and has a Zacks ETF Rank #3 (Hold).
PowerShares KBW Bank Portfolio (NASDAQ:KBWB)
This fund provides exposure to 24 leading national money centers and regional banks or thrifts by tracking the KBW Bank Index. It is concentrated on the top five firms that make up for at least 8% share each.
KBWB has managed $837.7 million in its asset base and trades in solid volume of 454,000 shares per day on average. Expense ratio comes in at 0.35%. KBWB added 2.8% in a week and has a Zacks ETF Rank #3.
SPDR S&P Regional Banking ETF (NYSEARCA:KRE)
This fund, having AUM of $3.1 billion and average trading volume of around 6.8 million, offers exposure to the regional banks. It follows the S&P Regional Banks Select Industry Index, charging investors 35 basis points a year in fees.
Holding 111 securities in its basket, KRE is widely spread out with each security holding less than 2.8% of assets. The fund has risen 3.5% in the same time frame and has a Zacks ETF Rank #3.
iShares Dow Jones U.S. Regional Banks ETF (NYSEARCA:IAT)
This ETF offers exposure to 53 regional bank stocks by tracking the Dow Jones U.S. Select Regional Banks Index. It is largely concentrated on the top two firms US Bancorp USB and PNC Financial Services PNC with a combined 28% of assets. Other firms hold no more than 7% share.
IAT has amassed $649.7 million in its asset base while sees good volume of 211,000 shares a day. It charges 44 bps in annual fees and surged 3.5% in a week. IAT has a Zacks ETF Rank #2 (Buy).
PowerShares KBW Regional Banking Portfolio (NASDAQ:KBWR)
This fund follows the KBW Regional Banking Index, holding 50 stocks in its basket with none holding more than 3.94% share. It is relatively less popular and less liquid options in the space, with AUM of $145.2 million and average daily volume of 40,000 shares.
KBWR charges 35 bps in fees per year from investors and is up 3.1% in a week’s time. The product has a Zacks ETF Rank #3.
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