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At its last meeting on April 29, the Federal Open Market Committee (FOMC) decided to keep the federal funds rate where it has been since December, in the 3.5% to 3.75% range.
It came as no surprise to anyone, as inflation has been ticking back up, driven by higher energy costs. And interest rate traders, according to the CME FedWatch poll, do not expect rates to come down this year.
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Financial stocks are among the most sensitive to interest rates, particularly banks. Banks, especially large banks, have a complicated relationship with rates, because some parts of their business thrive when rates are lower, while other parts prosper with higher rates.
Let's take a look at the two largest banks, JPMorgan Chase (NYSE: JPM) and Bank of America (NYSE: BAC), to see how the current rate trends are affecting them.
Both JPMorgan Chase and Bank of America shares rose slightly after the decision by the FOMC to keep rates where they are, but the move was negligible, and the shares dropped in the following days. In other words, it did little to change the negative trajectory both have been on this year. As of May 5, shares of both were down between 3% and 4%.
Higher rates are often good for banks because they can charge higher interest on their loans. On the other hand, they have to pay out more interest on deposits, too. But generally speaking, large banks, because of the other services they offer and the loyalty of customers, can generate higher net interest income when rates rise, because their deposit rates don't have to be as competitive as perhaps smaller banks.
On the other hand, when rates are higher, loan activity may not be as robust. So while banks may get higher net interest margins, they may not be making as many loans.
That happened to both JPMorgan Chase and Bank of America in the first quarter. While rates were lower this year than they were in the first quarter of last year, both banks generated more revenue and higher net interest income because loan activity was up.
So, rates staying the same is not necessarily a bad thing for either bank, as loan activity remains robust and interest rates are still somewhat elevated. It may in fact be a sweet spot for banks.
The first quarter was one of the best in recent years for mergers and acquisitions due to the lower interest rate environment. Lower rates make the cost of acquisitions fall, which spurs activity.
Of course, if rates came down at the last FOMC meeting, that would spur even more M&A activity, but keeping them where they are probably won't hurt at all. Both JPMorgan Chase and Bank of America are top five investment banks, so they were both buoyed by all the M&A activity in Q1.
The reason both these stocks are down is tied to economic doubts and rising inflation, due in large part to the war in Iran. When there is economic turmoil and rising prices, there's typically less spending and fewer loans, which hurts banks.
But for investors, both stocks look like solid buys, even with the upheaval, as both are trading at low multiples and should be well positioned to grow, barring a long, protracted war that leads to an economic downturn.
A third stock to watch is AGNC (NASDAQ: AGNC), a mortgage real estate investment trust, or mREIT. AGNC buys up mostly agency mortgage-backed securities, meaning those mortgages pooled together and sold by Fannie Mae, Freddie Mac, and government agencies. It borrows at lower short-term rates to buy these long-term securities with higher yields and it profits on the spread.
AGNC is even more sensitive to rate fluctuations than the banks. That's because when rates go up, the book value of the loan portfolio goes down, because investors can get better short-term rates elsewhere. And when interest rates go down, it's the opposite; the book value of the portfolio is higher as it looks more attractive compared to other short-term rates.
With rates staying the same in April and likely for the foreseeable future, AGNC stock should remain fairly stable. The primary value of AGNC stock is its dividend, which it pays out monthly and has steadfastly maintained at $0.12 per share since 2020.
And it currently pays out a super-high dividend yield of 13.5%, which should be safe as long as rates don't rise.
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JPMorgan Chase is an advertising partner of Motley Fool Money. Bank of America is an advertising partner of Motley Fool Money. Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends JPMorgan Chase. The Motley Fool has a disclosure policy.
3 Financial Stocks to Watch After the Fed Held Rates Steady was originally published by The Motley Fool