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Bank Stocks Slide as Fed Meeting Begins

NEW YORK ( TheStreet) -- Zions Bancorporation (ZION - Get Report) of Salt Lake City led U.S. bank stocks lower on Tuesday, with shares sliding 1.7% to close at $28.07.

The broad indices all pulled back as the Federal Open Market Committee began its two-day policy meeting.  Investors are wondering whether the committee will decide on Wednesday to taper the Federal Reserve's "QE3" purchases of long-term U.S. Treasury bonds and agency mortgage-backed securities, which have been running at a net pace of $85 million a month since September 2012.  The purchases have been meant to stimulate the economy by holding long-term interest rates down.  While long-term interest rates are still at low levels, the market yield on 10-Year U.S. Treasury bonds has risen to 2.85% from 1.70% at the end of April, as investors have anticipated the begining of a slowdown in central-bank bond buying.

Any change in stimulus policy will be discussed by outgoing Federal Reserve chairman Ben Bernanke during a press conference Wednesday afternoon.

Most economists expect Federal Reserve stimulus policy to remain unchanged until some time during the first quarter of 2014.  The FOMC will be considering plenty of positive economic data, including the upward revision of the third-quarter gross domestic product growth estimate to an annual rate of 3.6% from the previous estimate of 2.8%, and a decline in the U.S. unemployment rate to 7% in November from 7.3% in October.

On the other hand, slow inflation may keep pressure off the Fed to make a change.  The Bureau of Labor Statistics on Tuesday said the consumer price index for all items was unchanged for November, while rising 1.2% from a year earlier.  Excluding food and energy, the CPI was up rose 0.2% during November, with prices rising 1.7% from a year earlier.  Economists polled by Thomson Reuters on average had expected the CPI and core CPI both to increase by 0.1% during November.

The expectation for a continued increase in long-term interest rates bodes well for life insurers, which have seen a very strong stock run this year.

But banks are likely to see continued pressure on their net interest margins during 2014 according to RBC Capital Markets, which actually has a pretty positive outlook for the sector's stock performance next year.

What most banks need to see expanding net interest margins and significantly higher net interest income is a parallel rise in interest rates, which will require a change in the Fed's policy for the short-term federal funds rate, which has been locked in a target range of zero to 0.25% since late 2008.  the FOMC has repeatedly said this "highly accomodative" policy would likely remain appropriate until the unemployment rate falls below 6.5%, assuming inflation is held in check.

Bernanke has said it might be appropriate for the federal funds rate to remain right where it is even after the unemployment rate falls below 6.5%.  Any deviation on Wednesday from his past remarks will be of great interest to investors and bankers.

The KBW Bank Index (I:BKX) on Tuesday was down 0.8% to 66.58, with all 24 index components ending with declines.

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