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Goldman Lifts View of Discount Brokers

Discount brokers surged Friday as Goldman Sachs improved its outlook for the group, citing expected benefits from the Federal Reserve's decision to raise the interest rate it charges banks at the discount window.

NEW YORK (

TheStreet

) -- Discount brokers, including

Charles Schwab

(SCHW) - Get Report

and

TD Ameritrade

(AMTD) - Get Report

, surged Friday after Goldman Sachs improved its outlook on the sector, citing eventual benefits from the

Federal Reserve's

decision to raise the interest rate charges to banks at the discount window.

Goldman Sachs analyst Richard Ramsden lifted his overall assessment of the discount brokers to neutral from cautious, and specifically upgraded Schwab to neutral from sell.

While Ramsden noted his prior view that rates will remain "lower for longer" was unchanged, he explained the softening of his bearish stance, calling the Federal Reserve's move is a reminder that "rate pressure is cyclical, and while it may last long, it will not last forever." He added that he sees "limited further downside" in the stocks at these levels in the wake of the Fed's decision.

"While the Fed did not adjust the target federal funds rate today and in fact reiterated the process was not intended to be an indication of economic tightening, a process to unwind emergency measures that were put in place during the financial crisis appears to be underway," the note states.

The discount brokers are "highly sensitive to changes in short-term rates, Treasury Yields and the shape of the yield curve," Ramsden writes. "While we are not currently adjusting our estimates given uncertainty in scope and timing of any change n the shape of the yield curve, the downside risk to our estimates appears more limited than it had previously been."

With interest rates at historic lows, the discount brokers have been forced to waive fees on money-market funds in recent quarters. Schwab, for example, waived a total of $224 million in related fees in fiscal 2009, including $110 million in the fourth quarter. Net interest revenue for various assets also suffers, of course.

Goldman's Ramsden said Schwab is "the most sensitive name in our discount brokerage coverage group to rising interest rates with a 41% EPS upside to the first 100 basis point change in Federal Funds rates," adding that the company is also in a good position to attract both retail and institutional assets.

The firm also made a number of positive adjustments to price targets for stocks within the group, lifting the 12-month target on Schwab by $2 to $18, and going up $2 to $17 on

optionsXpress

TheStreet Recommends

, and moving 50 cents higher to $7.50 on

TradeStation

(TRAD)

.

In the same note, Ramsden reiterated a sell rating on

Federated Investors

(FII) - Get Report

citing the continued acceleration of money outflows at the company. The issue is likely to persist "even if the short end of the curve steepens," Ramsden writes in the note.

Schwab

kicked off a round of positive reports from the brokers last Friday when it said average daily client trades totaled 354,700 for January, up 23% from December and 8% higher than activity in the year-earlier period. Included in that number are DARTs, or daily average revenue trades (that which Schwab receives a commission on), of 304,000 for January, up 21% from the December month.

Friday's upgrade comes just two days after FBR Capital Markets analyst Matt Snowling boosted

TD Ameritrade

to a buy rating, citing its own improved monthly trading metrics for January after several months of declines as well as positive outlook on earnings growth for the firm vs. its competitors.

Schwab's stock was surging 5.3% to $18.76, on above-average trading volume of about 15.3 million shares. Shares of TD Ameritrade were up a solid 3.2% to $18.15, on volume of about 6.4 million shares.

E*Trade Financial

(ETFC) - Get Report

, another rival, was also in positive territory on Friday, up marginally to $1.56. OptionsXpress and TradeStation were rising roughly 5% and 6% respectively.

--Written by Laurie Kulikowski in New York.