If there's one constant in the stock market, it is change. When the year began, Wall Street was expecting rate cuts. Rising inflation and a strong employment picture shifted that view, with the outlook now including rate increases later in the year. Or at least that's the big picture takeaway from new Federal Reserve Chairman Kevin Warsh's first Fed meeting.
While it isn't exactly good news that inflation is high, at least partly due to high energy prices driven by the conflict in the Middle East, it isn't fully bad news, either. In fact, steady to higher rates could actually be a net benefit for big banks. Here's why.
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No change is good for now
The big, headline-grabbing finance story lately was the initial public offering (IPO) of SpaceX (SPCX 3.07%). The company raised a record amount of cash through a public offering, and the stock rose sharply following its debut. There are other big-name technology stocks lining up to go public as well, including artificial intelligence (AI) leaders like Anthropic and OpenAI.
The Federal Reserve's decision to hold rates steady rather than raise them is a net positive for investment banks like Goldman Sachs (GS 5.02%) and JPMorgan Chase (JPM 1.08%), both of which played a role in the SpaceX IPO. These companies need investors to be positive about the future as they try to sell shares in new companies. If the Fed had raised rates, it could have led to a negative outlook for investors and less willingness to buy IPOs. Indeed, IPOs often get called off during bear markets.
NYSE: GS
Key Data Points
So there's a longer window of opportunity for investment banks to bring big deals to market. But that window may not be long, as the Fed's bias appears to be for higher rates in the future.
Higher rates can help banks in other ways
Looking at the more traditional banking business of taking deposits and making loans, steady to higher rates is likely to be a net positive. If higher rates trigger a recession and/or bear market, that would clearly be a negative, of course. However, banks like Citigroup (C 2.36%) and Bank of America (BAC 0.17%) can charge higher rates on the loans they make if interest rates rise. When rates fall, they earn less in interest. So stable-to-higher rates are good news.
In fact, rising rates would be even better than stable rates. That's because banks can raise loan rates quickly, but they can slow walk the interest they pay depositors. The end result is a widening in the spread they earn, since their profit, in simple terms, is the difference between what they charge on loans and what they pay on deposits.
NYSE: BAC
Key Data Points
Eventually, Bank of America and Citi will have to increase what they pay depositors, of course, but if rates rise over several meetings, the runway for near-term profits could be quite strong. Unless, of course, rate increases trigger a recession, in which case the economic slowdown would likely reduce demand for loans and could even result in an uptick in loan defaults. There's a balance here, which the Fed is well aware of as it attempts to cool inflation without tanking the economy.
This isn't new territory for big banks
While the current economic situation is unique in its own way, rates go up and down all the time. Banks are used to dealing with the directional shifts. While Kevin Warsh is new to the Federal Reserve, banks aren't new to the rate change game. And, thus, they aren't likely to have been surprised by the Fed decision or the fact that rates now look more likely to increase in the future. While this meeting garnered extra attention from Wall Street, it isn't really that big a story if you are a long-term investor. Well-run banks should still have a place in your portfolio.
