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As Fed Hikes, Only Pockets of Value in Banks

The banks set to benefit the most from higher rates are quite pricey today, but we do see credit card issuers Capital One and American Express as undervalued.

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Jim Sinegal: The Federal Reserve announced that it will be continuing along the path to slow interest rate normalization today. The Federal Reserve Open Market Committee decided to raise the target federal funds rate by 25 basis points. That's not surprising, given the economic progress that's occurred over the last year. We've had significant job gains, the unemployment rate is low, consumer spending is up, as is business investment.

The one sticking point is still inflation, which remains below the Federal Reserve's 2% target. The Fed believes that this momentum in the economy will eventually raise inflation up over 2%. We've seen some small hints in the data, nothing yet to be concerned about, but the Fed is trying to get ahead of the puck here, so to speak.

In terms of what it means for the banks, regional banks are very sensitive to interest rates. Banks like M&T and Regions Financial are asset-sensitive. That means they'll continue to benefit as rates go up. On the other hand, we're going to start to see signs of increasing deposit beta going forward. Basically, that means the banks are going to be paying out more of these benefits from rising rates to customers. So, it's good for savers, not as much for bank investors.

We also think that higher rates will lead to growing advantages for banks with large bases of sticky, low-cost retail deposits. If you're not paying anything on your deposits at all, you have an even bigger advantage as rates continue to go up. Unfortunately, banks like Regions and M&T are 25% overvalued right now. Where we're seeing opportunity is actually in the less rate-sensitive credit card names. Capital One is undervalued right now, as is American Express. We like American Express' plans to reinvigorate their reward offerings and think that company is poised to do very well under new management.

Jim Sinegal does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.