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How important are the carefully chosen words of the Federal Open Market Committee? They are very important.
The Fed did not take action at its meeting Wednesday, and no one expected it to bump rates at this time. What the Fed did do was remove the word “patient” from its statement regarding rate policies.
With stocks struggling for the past few weeks due to increasing concern that the Fed was set to hike rates sooner rather than later, stocks soared in the minutes following the Fed announcement.
While this seems to open the door for a rate hike as early as the Open Market Committee meeting in June, the Fed also took a more cautious outlook on economic growth in the U.S.
With these statements, the market took off. At the time of the announcement, the S&P 500 was down approximately 12 points. By the end of the day, the S&P had gained almost 24 points. From the low just before the Fed announcement to the high just after the announcement, the S&P experienced a 45-point swing in the last two hours.
What jumped out at me wasn’t so much the overall market as what happened to the banking sector after the meeting. Prior to the announcement, and in the last few weeks, the SPDR KBW Bank Index ETF (NYSE: KBE) had held up relatively well. We can see that on the intraday chart the last couple of weeks:
The notation I made was for 2:00 p.m. ET on Wednesday – the 30-minute bar that represents that first half hour of trading after the announcement. The KBE was trading close to its high for the last 10 days. The fund was able to bounce back a little in the last half hour of trading, but I think there are two bigger underlying problems that the bank stocks face.
If we step back and look at the weekly chart of the KBE, we see that the fund has been range-bound for the last year and a half. It hasn’t been able to move above $35 and has only spent a brief amount of time below the $30 level. It just banged up against that resistance on the top of the range and it looks like it could head down again.
We also see from the weekly chart that the fund is overbought based on the weekly stochastic readings. Even though the daily chart isn’t included here, the daily stochastic readings were in overbought territory until yesterday and then they made a bearish crossover.
Yet another issue facing banks are the low interest rates. With the Fed maintaining a cautiously optimistic outlook and leaving itself the flexibility to not raise rates, banks are stuck with the lower rates – and thus the lower spread between the rate they can loan money at and the rate they pay on deposits.
Banks would rather see higher rates. If interest rates as a whole are higher, banks have a little more flexibility with the spread between their lending rates and the rates they pay out. As long as the Fed keeps rates low, banks will have to deal with tight spreads.
I may have taken a long road to get here, but my thought on the KBE is that it should be shorted, with another trip down to the $30 level being the target. That is only an 11.3% drop from where the stock closed on Wednesday, but if it happens quickly that isn’t too bad.
Another possibility would be to buy put options on the KBE, perhaps the June 36 strike puts. They have three months until they expire, they are in the money by $2.40 at this point and the asking price is only $3.30. Should the fund drop to $30, the intrinsic value of the options would be $6, or almost double the current asking price.
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