Bank stocks rise as Fed hikes again

US bank stocks advanced July 26 as the Federal Reserve delivered on expectations for another rate hike of 25 basis points, bringing the range for the central bank's policy target to 5.25% to 5.5%.

The KBW Nasdaq Bank Index increased 1.9% for the day, building on gains before the rate decision was announced at 2 p.m. ET. The S&P 500 was down about 0.2%.

Futures markets had put about a 97% probability on a rate hike of that size as of the morning before the announcement. They were also betting that the hike would be the Fed's last before cutting rates in 2024.

Market expectations for rates are below those projected by Fed policymakers in their most recent formal forecast on June 14, where the median expectation for federal funds at the end of 2023 was 5.6%, and 4.6% at the end of 2024. Those expectations have nevertheless shifted toward higher-for-longer recently, with Treasury yields increasing meaningfully across the curve during the three months through July 26.

Meeting by meeting

After a cumulative increase in the Fed's target of 5.25 percentage points since March 2022, "we're coming to a place where there really are risks on both sides" in terms of doing too much tightening and damaging the economy unnecessarily versus not doing enough to fight inflation, Fed Chair Jerome Powell said at a press conference. "It's hard to say exactly whether they're in balance or not."

Policymakers will continue to evaluate new data and make decisions "meeting by meeting," Powell said, keeping in mind "that financial conditions affect economic activity and inflation with a lag that can be long and variable."

Powell said not to expect cuts this year but added that policymakers have forecast rate cuts next year because restrictive policy would not be needed if indeed "we see inflation coming down credibly, sustainably."

A higher-for-longer path for interest rates implies greater and more sustained upward pressure on deposit costs, though higher rates also boost asset yields. Some banks, such as Huntington Bancshares Inc., have said they see a path to stable-to-rising net interest margins after substantial declines from peaks earlier during the hiking cycle.

Bank stock bounce

Bank stocks have done well over about the past month, with the KBW Nasdaq Bank Index gaining 13.1% from June 23 through the July 25 close and chipping away at its underperformance relative to the S&P 500 this year.

Addressing the health of the bank sector after the failures earlier this year, Powell said, "Things have settled down for sure out there. Deposit flows have stabilized, capital and liquidity remains strong. Aggregate bank lending was stable quarter over quarter and is up significantly year over year. Banking sector profits generally are coming in strong this quarter."

Powell said it is difficult to assess the impact that the banks closest to the turmoil are having on the broader economy but added that the Fed's most recent quarterly senior loan officer survey, due to be released next week, "is broadly consistent with what you would expect."

"You've got lending conditions tight and getting a little tighter," Powell said. "You've got weak demand."

Because of their March swoon, bank shares still mostly show losses for the year. Giants like JPMorgan Chase & Co. and Wells Fargo & Co., which have shown resilience to funding pressures, and banks like First Citizens BancShares Inc. and New York Community Bancorp Inc., which scored well-received acquisitions of failed peers, have been exceptions, posting gains thus far in 2023.

For the day, among the 20 biggest US banks by market capitalization, KeyCorp, Comerica Inc. and First Horizon Corp. were top performers, each with increases of greater than 5.0%.