Fed Minutes Hint At Rate Hike In June: Top 5 Gainers

Minutes from the Federal Reserve’s May 2–3 meeting showed that policymakers anticipate a rate hike soon, possibly in the central bank meeting next month. At the same time, by agreeing to shrink the balance sheet gradually over a number of years, the Federal Open Market Committee has minimized possibilities of market gyrations and its impact on economic growth.

This calls for investing in banks, insurance and brokerage houses as such institutions will see a ramp up in profits on an interest rate hike and stable economic conditions.

Fed Forecasts Rate Hike “Soon”

Federal Reserve’s latest policy meeting showed that officials believe that an interest rate hike is in the cards “soon”. And if economic reports come in as expected, the Fed could raise rates when it meets on Jun 13–14, a move that markets have been anticipating. Traders see a 79% chance of a rate hike in June, according to the CME Group (NASDAQ:CME). Lest we forget, talks of a hike in January had not matured as the hike had come in March.

Several Fed officials have said in recent weeks that they see a strengthening economy which is enough to warrant two more quarter percentage point rate increases this year. In fact, officials plan to stick to this stance even if the economy has faced a minor hit in the first quarter. And while some doubted the recent softness in inflation, it wasn’t able to knock them off the track. Most officials believe that the deceleration in price pressure was temporary, while only a few expressed concerns that progress toward the Committee’s objective may have slowed. The Fed’s preferred gauge of inflation, the personal-consumption expenditures index, did, briefly exceed the Fed’s annual 2% target in February, but, registered a greater-than-expected drop in March.

Fed officials, in the meantime, expect job additions, rise in household income and an upbeat consumer sentiment to bolster spending levels in the months ahead, and they took great comforts in improvement in business investments. This in turn could warrant a faster pace of rate hikes.

Gradual & Predictable Reduction in Fed’s Balance Sheet

The Fed also moved toward a consensus on a proposal to gradually unwind the massive balance sheet built up over the course of the asset buying program that was the core of Fed’s quantitative strategy. Beginning late 2008, the Fed started to accumulate treasury and mortgage-backed securities to counter a complete collapse of the financial system.

But the Fed does not want to reduce the massive $4.5 trillion balance sheet at one go. Rather, it plans to let it shrink as the securities mature. The Fed officials did agree to end the reinvestment of principal of maturing securities in slow but increasing stages. Such an approach will stay on auto-pilot, until and unless there is major deterioration in the domestic economic front.

With interest rate hikes and balance sheet reduction, investors may fear that economic tightening will occur too soon. But, nearly all Fed officials agree to a slow and cautious approach toward unwinding the balance sheet, which won’t slow down the economy drastically.

Who Stands to Benefit?

Higher interest rates can boost bank profits as they increase the spread between what banks earn by funding longer-term assets, such as loans, with shorter-term liabilities. The spread between long-term and short-term rates also expands during interest rate hikes because long-term rates tend to rise faster than short-term rates.

Non-banking financial institutions including insurance companies, asset managers and brokerage firms should also benefit. Rising rates act as a boon for insurance companies as they derive their investment income from investing premiums, which are received from policyholders in corporate and government bonds. Yields and coupons on these bonds rise in response to a hike in Fed fund rates and bank interest rates. This enables life insurers to invest their premiums at higher yields and earn more investment income, expanding their profit margins. Not only investment income, which is an important component of insurers’ top line, annuity sales should gain from a higher rate environment.

Brokerage firms and asset managers also advantage immensely from a rising rate environment since an increase in rates generally concurs during periods of economic strength and upbeat investor sentiments.

Top 5 Picks

Given the aforementioned benefits, we have selected five sturdy stocks from these areas that boast a solid Zacks Rank #1 (Strong Buy) or 2 (Buy). The search was also narrowed down with a Zacks Investment Research

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Written By: Zacks Investment Research