What happened
The broader markets struggled Thursday, with the Dow Jones Industrial Average closing Thursday's session down by 1,069 points, and the Nasdaq Composite was down roughly 5%. Large banks and mortgage originators were not spared.
At the close of trading, shares of Bank of America (BAC 0.45%) were down by 2.7%, and Wells Fargo (WFC 0.89%) shares were off by 2%. Shares of Rocket Companies (RKT -4.74%) were down 9.1%.
So what
Investors are clearly reacting to the Federal Reserve's decision Wednesday to raise its benchmark overnight lending rate, the federal funds rate, by 0.5 percentage points. That was expected, but it was larger than the Fed's normal 0.25 percentage point hikes. Federal Reserve Chairman Jerome Powell did, however, say that the Fed is not currently considering implementing 0.75 percentage point rate hikes in the future. Some investors had been worried about that possibility. The Fed also said that it plans to start reducing its massive balance sheet, which effectively means pulling liquidity out of the economy. The Fed will ramp up to running $95 billion worth of bonds per month off its balance sheet by September.
Image source: Getty Images.
The market seemed to like the news Wednesday -- the Dow added 900 points. But Thursday, the trend and the market's mood reversed. Stocks struggled to sustain any kind of momentum and overcome the uncertainty that lies ahead.
"Make no mistake, the Fed is in the early stages of what we believe will be a very aggressive tightening cycle," Win Thin, global head of currency strategy at Brown Brothers Harriman, wrote in a research note.
Not everyone expected such a negative move from the market Thursday. Kim Forrest, the chief investment officer at Bokeh Capital Partners, said the "great puking that's happening" caught her off guard.
"Is this capitulation? I remember what capitulation feels like -- this kind of feels like capitulation, when everything, even the good names, are getting barfed out," she said.
Bank stocks tend to benefit from interest rate hikes because those offer them the opportunity to invest their deposits at higher rates, whether into loans or bonds. But rising rates can also have negative effects on banks by raising the costs of deposits and increasing their loan losses. Additionally, many are concerned the Fed is going to have a difficult time engineering a soft landing for the economy as it fights to cool off high inflation, and could instead tip the U.S. into recession. That would also be bad news for banks because it would slow consumer and business spending.
Rocket Companies, the largest mortgage originator in the U.S., has had a rough go of it since it went public in August 2020. The stock is down by just over 50% from its IPO price. While Rocket benefited from the ultra-low-rate environment that has prevailed throughout the pandemic, which drove a surge in refinancing activity, mortgage rates have shot up this year. The average rate of a 30-year fixed-rate mortgage is now up to 5.27%, its highest level since 2009.
Now what
It's a bit hard to predict right now what the housing market -- and therefore mortgage activity -- will be like for the balance of this year. Higher mortgage rates will certainly slow activity, and those consumer rates could continue to rise as the market anticipates more hikes to the benchmark rates for financial institutions. However, they have already risen extremely rapidly this year, so perhaps the pace will start to slacken a bit. The housing market also remains tight, with a shortage of inventory and more millennials getting into their prime home-buying years.
While there is the possibility of a recession, banks like Bank of America and Wells Fargo should see profits rise this year along with rising interest rates. In general, I see these two stocks as good long-term buys.
