The hope of another rate hike in the near term took a nosedive after Federal Reserve Chair Janet Yellen stated that the U.S. central bank should proceed cautiously in adjusting policy rates. Yellen's dovish comments were in stark contrast to several Fed officials who last week hinted at a sooner-than-expected rate hike, potentially in April or June.
While addressing the Economic Club of New York, Yellen noted that only gradual increases in the federal funds rate are likely in the coming years. She cited an uncertain economic environment, the employment scenario and inflation goals for the extremely cautionary stance. Appropriately, a gradual pace of rate hikes will be established to achieve and maintain two primary criteria – maximum employment and an inflation rate of 2%.
Yellen also highlighted changes in the economic environment since December, when the Fed raised rates for the first time in nearly a decade. She noted that since the beginning of the year, readings on the U.S. economy have been mixed. While many indicators including labor market data, declining unemployment rate, moderate expansion of consumer spending and housing market recovery were favorable, a continued decline in manufacturing and net exports owing to slow global growth and the significant appreciation of the dollar can't be ignored. The continued slump in oil prices has also impacted the economy adversely (read: US Hires More than Expected in Feb: ETFs & Stocks to Buy).
In light of these considerations, it is not surprising that the Federal Open Market Committee (FOMC) decided to leave its stance on policy unchanged in both January and March. In March, the central bank announced that it now expects the federal funds rate to rise to 0.875% by the end of the year, instead of the previously expected 1.375%, implying only two rate hikes as compared to the four projected in December (read: ETFs to Watch Post Fed Meeting).
As the rates are likely to remain low longer than expected, financials stocks and ETFs have turned up as the major losers. In fact, with Treasury yields hitting multi-week lows after the release of Yellen's remarks, banks are expected to be the worst hit. Low rates put pressure on banks' net interest margin – a measure of the difference between the rates at which banks borrow and lend. KBW NASDAQ Bank Index went down 2.8% in the last five days.
As per an analyst at CLSA, the Fed's dovish stance is expected to cost the U.S. banking industry about $5 billion. In this scenario, let's look at a few prominent U.S. bank ETFs and their performance (see all Financial ETFs here).
SPDR S&P Bank ETF (KBE)
This fund tracks the S&P Banks Select Industry Index and has an AUM of $2.3 billion. Volume is good as it exchanges more than 2.9 million shares a day while the expense ratio is at 0.35%. The product holds a diversified basket of 64 stocks with none holding more than 2.2% of total assets (read: Bank ETFs in Trouble?).
From a sector look, about three-fourths of the portfolio is allotted to regional banks while diversified banks, thrifts & mortgage finance, asset management & custody banks and other diversified financial services take the remainder. KBE currently has a dividend yield of 1.92%. The ETF has lost 2.5% in the last five days and holds a Zacks ETF Rank #2 (Buy) with a High risk outlook.
SPDR S&P Regional Banking ETF (KRE)
