Banks Stocks Roar on 'Fed Taper' Day

Updated from 3:37 p.m. ET with market close information, additional comments from outgoing Federal Reserve chairman Ben Bernanke and comments from San Diego State University finance professor and economist Dan Seiver.

NEW YORK (TheStreet) -- Bank of America (BAC) led large-cap U.S. banks higher Wednesday afternoon, with shares up 3.6% to close at $15.70, following the announcement of the Federal Reserve's plans to begin tapering its purchases of long-term bonds in January.

The broad stock indices rose considerably after the Federal Open Market Committee concluded its two-day meeting and announced the central bank would trim its monthly purchases of long-term U.S. Treasury bonds to $40 billion from $45 billion and reduce its monthly purchases of long-term agency mortgage-backed securities to $35 billion from $40 billion, beginning in January.

The Dow Jones Industrial Average was up 1.9%, while the S&P 500 was up 1.7% and the NASDAQ Composite was up 1.2%.  The KBW Bank Index I:BKX was up 2.1% to 68.00, with all 24 index components showing afternoon gains. Shares of M&T Bank (MTB) of Buffalo, N.Y., erased earlier losses to close with a gain of 0.6% at $114.36.  The bank late Tuesday announced another long delay for regulatory approval of its expected acquisition of Hudson City Bancorp HCBK of Paramus, N.J.

As part of its "QE3" efforts to hold down long-term interest rates, the Federal Reserve has been buying a net $85 billion in long-term bonds since September 2012.  The FOMC said the reduction in net bond purchases to $75 billion was decided upon, "In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions."

The market yield on 10-year U.S. Treasury bonds had risen as high as 2.91% before the FOMC released its statement, but after the tapering was announced, the 10-year yield dropped a bit to 2.89%, up 5 basis points from Tuesday.

Recent positive economic reports considered by the FOMC included a revision in the estimate of third-quarter gross domestic product growth to an annual rate of 3.6% from the previous estimate of 2.8%, and the decline in the unemployment rate to 7% in November from 7.3%.  

The FOMC also released economic projections, showing a "central tendency" of projections -- throwing out the three highest and three lowest projections -- of a GDP growth rate ranging from 2.8% to 3.2% and continued improvement in the unemployment rate to a range of 6.3% to 6.6% during 2014.

Both figures will be of great important to banks and their investors next year.  Most big banks are expected to face continued pressure on their net interest margins next year, because the federal funds rate has remained in a historically low range of zero to 0.25% since late 2008.  The FOMC made no change in this policy Wednesday, and repeated its past language that keeping the federal funds rate near zero "will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored."

Curtailing the bond purchases will drive long-term interest rates higher.  But 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 the Fed to raise the target for the federal funds rate.

The U.S. unemployment rate improved to 7.0% in November from 7.0% in October.  Recent inflation reports show annualized U.S. inflation running well below the Federal Open Market Committee's long-term goal of 2%, so it would appear there's no short-term pressure for the Fed to raise the federal funds rate. 

San Diego State University finance professor and economist Dan Seiver isn't surprised at the timing of the Federal Open Market Committee's tapering decision, since "hey were warning they might do it and the economic data was coming in stronger, probably than they expected. So it was appropriate for them to start.  Knocking $10 billion off wasn't a big surprise either."

In a phone interview, Seiver called the euphoric reaction among stock investors "a bit of an over-reaction, but for all of us who own stocks, it's great."

When discussing the federal funds rate, Seiver said, "What the Fed wants to do is transition away from quantitative easing and back to using short-term interest rates as a policy tool."

He expects the federal funds rate to remain in its current range "all of next year and probably into 2015, even if the unemployment rate gets down to 6.45%, contingent upon inflation staying very low."

Bernanke's Press Conference

Outgoing Federal Reserve Chairman Ben Bernanke in a press conference Wednesday afternoon said "the unemployment rate is probably the best single indicator that we have" of improvement in the labor market.  However, since the FOMC is also considering job creation and labor participation rates as part of a "broad set of labor market indicators," Bernanke said "I expect it will be some time, past the 6.5%, before all of the other variables that we are looking at will line up in a way that will give us confidence that the labor market is strong enough to withstand the beginning of increases in [short-term interest] rates."  

Bernanke provided plenty of fascinating observations about the current economic cycle, his frustration at the slow pace of economic growth and the great likelihood for the central bank to maintain a "quite large" balance sheet for "a very long time."

"People don't appreciate how tight fiscal policy has been," Bernanke said.  "At this stage in the last recession -- which was a much milder recession -- state, local and federal governments had hired an additional 400,000 from the trough of the recession.  At the same point in this recovery, the change in state, local and federal government workers is minus 600,000, so there's about a million workers difference in how many people are employed at all levels of government."

"So fiscal policy has been tight, contractionary, and there have been a lot of headwinds." Bernanke said.

He added that "we don't fully understand" the slow pace of growth."

"But compared to other advanced industrial countries recovering from financial crises, the U.S recovery has actually been better than most," Bernanke said.

The outgoing Fed chairman said the economic recovery "has not been satisfactory, we still have a labor market where it's not easy to find work,... but given all the things that we faced, it is perhaps, in retrospect, not that shocking that this recovery has been somewhat tepid."

Bank of America

Shares of Bank of America have returned 36% this year, after more than doubling during 2012.  The shares trade for 1.2 times their reported Sept. 30 tangible book value of 13.62.  The shares trade for 11.9 times the consensus 2014 earnings estimate of $1.32, among analysts polled by Thomson Reuters, and for 9.9 times the consensus 2015 EPS estimate of $1.59.

The following table shows this year's performance this year of Bank of America's stock against the KBW Bank Index and the S&P 500:

BAC Chart
BAC data by YCharts

Interested in more on Bank of America? See TheStreet Ratings' report card for this stock.

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

More from Investing

REPLAY: Jim Cramer on How to Navigate the Stock Market Amid Tariff Worries

REPLAY: Jim Cramer on How to Navigate the Stock Market Amid Tariff Worries

Will Kraft Heinz Buy Pepsico or Mondelez?

Will Kraft Heinz Buy Pepsico or Mondelez?

Jim Cramer: 4 Stocks Could Get Throttled By a 'Knock Down Drag Out' With China

Jim Cramer: 4 Stocks Could Get Throttled By a 'Knock Down Drag Out' With China

Why Starbucks Latest Data Reveal Should Worry Investors

Why Starbucks Latest Data Reveal Should Worry Investors

Starbucks Sets Latest Plan to Recaffeinate Shares

Starbucks Sets Latest Plan to Recaffeinate Shares