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Bank Stocks Pull Back As Employment Growth Disappoints

Stocks in this article: BKI:BKX

NEW YORK ( TheStreet) -- Bank of New York Mellon (BK) led large U.S. banks lower on Friday, with shares declining 1.5% to close at $34.23.

The broad indices ended mixed, after the Department of Labor said the U.S. economy added 74,000 nonfarm jobs during December, which was a far cry from the average employment growth estimate of 192,000, among economists polled by Reuters.

The KBW Bank Index (I:BKX) on Friday pulled back 0.4% to 70.78, with all but seven of the 24 index components ending lower.

The U.S. unemployment rate continued its rapid decline, to 6.7% in December from 7.0% in November and 7.3% in October.  Economists had expected the unemployment rate for December to remain unchanged at 7.9%.

The "good news" for the unemployment rate in December was been driven in part by a 0.2% decline in the labor participation rate to 62.8%.  The labor participation rate declined 0.8% during 2013 -- a large number of people have effectively been driven from the labor force.

During 2013, one of the major economic themes was the expected tapering of the Federal Reserve's monthly "QE3" purchases of long-term bonds, meant to hold long-term interest rates down.  The Federal Open Market Committee in December finally announced that the Fed's monthly bond purchases beginning in January would be lowered by $10 billion to $75 billion.  The market yield on 10-year U.S. Treasury bonds has risen accordingly to 2.87% from 1.70% at the end of April.

Even though long-term interest rates remain at historically low levels, this increase has been enough to curtail the wave of mortgage loan refinancing activities banks have enjoyed over the past several years.  Lower mortgage revenue and continued pressure on net interest margins will be major themes for banks' earnings season, which begins on Tuesday, when JPMorgan Chase (JPM) and Wells Fargo (WFC) announce their fourth-quarter results.

Some investors may wonder why banks' margins are continuing to be pressured, since long-term interest rates have risen significantly.  The problem for the banks is that they are positioned to benefit from a parallel rise in interest rates, which can only come about when the Fed raises the short-term federal funds rate, which has been stuck in a range of zero to 0.25% since late 2008.

This makes the unemployment rate a key indicator for 2014, probably overshadowing all of last year's "taper talk."

The Federal Open Market Committee has repeatedly said that barring a rise in inflation, it is unlikely to raise the federal funds rate until the U.S. unemployment rate falls below 6.5%. We're getting close to that level, but incoming Fed Chairwoman Janet Yellen and other policymakers may hesitate to raise the federal funds rate, because of the decline in the labor force. 

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