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Morgan Stanley Leads Banks Lower After Downgrade

Stocks in this article: MS C I:BKX ^GSPC

NEW YORK (TheStreet) -- Morgan Stanley (MS) led large-cap bank stocks lower on Thursday, with shares sliding 3% to close at $30.21.

The broad indices all ended lower following a huge upward revision of third-quarter U.S. gross domestic product growth by the Bureau of Economic Statistics to an annual rate of 3.6% from the previous estimate of 2.8%.  Economists polled by Thomson Reuters on average had expected the second GDP growth rate estimate to come in at 3.0%. 

The GDP growth rate increased from 2.5% in the second quarter, however, the news was not all positive, as "Real personal consumption expenditures increased 1.4 percent in the third quarter, compared with an increase of 1.8 percent in the second," according to the Bureau of Economic Statistics.

Also on Thursday, the Department of Labor said initial U.S. unemployment claims for the week ended Nov. 30 declined by 23,000 from the previous week to 298,000.  Economists on average had expected jobless claims to total 329,000.

The KBW Bank Index (I:BKX) was down 1% to 66.47, with all but two of the 24 index components ending with declines.  In addition to Morgan Stanley, large-cap banks seeing significant share-price declines included JPMorgan Chase (JPM), which was down 2.4% to $55.80, and Citigroup (C), which gave up 1.9% to close at $51.06.

In the midst of a two-year bull run for the U.S. stock market, investors are skittish over the prospect of a significant increase in long-term interest rates when the Federal Reserve begins to curtail its "QE3" purchases of long-term U.S. Treasury bonds and agency mortgage-backed securities.  The bond purchases have been running at a net pace of $85 billion a month since September 2012. 

Most economists were surprised when the Federal Open Market Committee cited conflicting economic data when it decided in September not to begin "tapering" the bond purchases.  Since then, the partial shutdown of the federal government during the first half of October and an increase in the U.S. unemployment rate to 7.3% in October from 7.2% in September seemed to make near-term tapering unlikely.  But the steady flow of positive data this week could be raising investors' fears that the a decline in central bank bond purchases could be announced after the FOMC next meets on Dec. 17-18. 

But the FOMC is likely to continue to see conflicting economic data, according to Sterne Agee chief economist Lindsey Piegza, who wrote in a note to clients on Thursday that because third-quarter GDP growth mainly reflected an increase in inventories, while consumer spending growth slowed, "overzealous production last quarter is likely to severely contract from the current quarter's growth."

"Given the fragile consumer sector and tepid business investment end of the year growth is unlikely to push above 2%," she wrote.

The continued reduction in unemployment claims, together with the report fon Wednesday rom Automated Data Processing that private U.S. employers added 215,000 jobs during November, shed light on the Federal Reserve's main policy tool.  This is not QE3, but rather the short-term federal funds rate, which has been stuck in a historically low target range of zero to 0.25% since late 2008.

While many investors fear the disruption of a rise in long-term rates and falling bond prices that are likely to follow a tapering of the Fed's bond purchases, most bankers are licking their chops when considering the parallel increase in interest rates that will occur when the federal funds rate finally begins to rise.

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