Bondholders Are Right to Be Bullish on Banks, Analyst Says

Bondholders generally underestimate the power of stable banks to drive the economy, Robert Hawkins of the investment research firm Janney Montgomery Scott wrote in a recent research note.

That could make them attractive stocks to invest in now that the Federal Reserve is likely to raise interest rates this year — the expectation the central bank set out in its new official statement last week.

Hawkins said that when he bought Bank of America a few months ago it had shed over 4.5% in that time. That’s about the same loss as Macy’s, Wendy’s and Ford have suffered in the same period.

“Investors are worried that the Federal Reserve will curb bank lending, which will dampen economic growth,” he wrote. “I don’t believe that this will happen.”

Banks are far more stable than companies, as they have nowhere to go but up with interest rates rising.

Through several decades of weak and volatile economic growth, banks consistently generated high returns for investors. Investors will be pleased to see rising interest rates and higher interest rates on loans eventually begin to boost bank earnings.

Currently the Federal Reserve is constrained by a range of both economic and political conditions. Several of those constraints might ease significantly by the end of this year.

Here are some of the few factors that might lift interest rates faster than expected:

The Fed currently has a “target range” for short-term interest rates in a range of 2% to 2.25%. The FOMC (Federal Open Market Committee) has stated that it would need to raise interest rates at a faster rate if the economy accelerated.

Improvements in the relationship between short-term rates and long-term rates and the risk that global financial turmoil would impact the U.S. economy have pushed investors toward an expectation of more rapid interest rate hikes than the FOMC previously anticipated.

President Donald Trump’s trade wars could slow U.S. economic growth by driving up prices.

The Fed might actually need to slow its rate hikes if financial markets stabilize following this summer’s significant events like Brexit and European elections.

The Fed also might need to act more slowly than originally thought if financial markets enter a more volatile state.

It might not be unreasonable to expect the FOMC to begin hiking rates at a faster pace than before if emerging markets resume uncertainty and the effects of global trade wars continue to hurt economic growth.

Having higher rates and rising interest rates mean higher returns for bondholders, which could boost an investor’s portfolio’s yield and reduce the overall risk of a bond investment.

Bondholders are right to be bullish on banks, Hawkins argues.

“If history is any guide, Bank of America should appreciate strongly as we come closer to the rate-hike cycle,” he wrote.

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