Interest rate hike cycle to help improve banks' profitability

WITH another interest rate hike upon us, we expect the US bank stocks to perform well as the net interest margins (NIMs) continue to expand. The Fed will commence their two-day meeting on June 12. Based on the Fed Fund Futures, there is a 100 per cent probability of a 0.25 per cent interest rate hike, and that will lift the Fed Funds Rate (FFR) from 1.75 per cent to 2.00 per cent. As the interest rate hike cycle continues, we expect banks to report greater profitability in the coming quarters. NIM simply measures a bank's profitability. The wider it is, the greater the profitability.

Generally, there is a strong positive correlation between the interest rate hike cycle and bank stocks. For this article, we will be referencing the Financial Select Sector SPDR (XLF) as the proxy for the US bank stocks. XLF is an ETF that includes financial service firms whose business range from investment management to commercial and business banking. The last time the Fed began the rate hike cycle was in July 2004. The rate hike cycle lasted for two years where the FFR rose from 1.00 per cent to 5.25 per cent. The resulting impact on the XLF was a 32 per cent rally. Moving to current time, the most recent rate hike cycle that began in December 2015 has also lifted the bank stocks. Since the first rate hike in December 2015, there was five more 0.25 per cent rate hikes to date, bringing the FFR to 1.75 per cent currently. As the FFR moved higher, NIMs also widened along with it and hence, the XLF rallied 38 per cent during this rate hike cycle.

According to the most recent Fed's dot-plot projection, the FFR should be at 2.125 per cent by the end of 2018 and 2.875 per cent by the end of 2019. All in, we can still expect this current rate hike cycle to sustain, and that should continue to help with the expansion of NIMs.

Looking at the XLF charts shows a key support area coming into the spotlight. The banking stocks are currently at a major crossroad as it hovers around the US$26.76 support area. The recent price actions around the US$26.76 support area confirmed the importance of this level. It was first established in October 2017 as resistance as it caused a near-term top back then. However, after a strong performance in December, the bulls broke above the US$26.76 resistance area and had since then become a pivotal support area. The staggering 11 per cent selloff in February was halted impeccably by the US$26.76 resistance turned support area. Since then, there were three more strong bullish rejections off that support area shown by the highlighted boxes, suggesting that the bulls are defending that area at all costs. One can view the US$26.76 area as a floor on price that prevents it from falling lower. Thus, it can be treated as a dividing line between the bulls and the bears. If the price stays above US$26.76, the uptrend remains intact. However, if XLF closes below the US$26.76 support area, the uptrend might turn into an immediate downtrend where further downside pressure can be expected.

The US$26.76 support area happened to be at the 50 per cent Fibonacci retracement level too using the upswing from April 2017, hence reinforcing this support area as a sturdy one.

Therefore, with the expectation of seeing this interest rate hike sustaining into 2019, expect the solid floor at US$26.76 to hold and propel XLF back into the uptrend. For the bullish narrative to play out in full force, the XLF needs to break and close above the US$28.45 range high. Once that happens, the next leg of buying should begin where the bulls aim for the US$29.77 resistance area followed by the US$30.32 record high.

Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice