Will US banks continue to rally

Shares in US banking stocks have rallied hard over the last two sessions, with the S&P500 financial sector surging over 4% since Tuesday: let’s take a look as to what is happening. 

US banking stocks have been on a positive trajectory since President Trump won the election a year ago. Campaign promises of deregulation and tax reform captured investors attention and kept the sector pushing northwards. Whenever doubts appeared over Trump’s ability to push such reforms through, the sector eased back. Momentum in the sector has picked up sharply this week with the likes of JP Morgan, Bank of America and Citigroup jumping around 5%. This increase in momentum is down to several factors coming together simultaneously.  

1. Tax reform 

The banking sector is expected to be one of the sectors which will benefit the most from the tax reforms. A corporate tax cut to just 20% from 35% will help the bottom lines of big business such as the banks. This week has seen some developments in the progress of the US tax reform bill. 

The bill cleared its first hurdle in the Senate with approval from the Senate Budget committee. The bill is expected to be voted on in the Senate possibly as soon as today. Whilst the Republicans have such a slim majority of 52-48 in the house, it is essential that all Republicans get behind the bill. Signs of the bill progressing through the Senate could continue to boost these stocks. 

2. Rotation out of FAANG’s? 

Also related to tax reform, this week we have started to see a rebalancing of portfolios and a possible rotation out of FAANG stock (Facebook, Amazon, Apple, Netflix and Google owner Alphabet) into financials and industrials. FAANG’s have had a tremendous year rallying between 30% to 50% in the space of 11 months. Moving to the end of the year, portfolio managers are rebalancing away from these stocks. Furthermore, these tech stocks are unlikely to benefit as much from the US tax reforms, in fact they may find that loopholes they have relied on to keep effective tax low, will be closed. 

3. Jerome Powel 

Powel has been selected by President Trump to replace Federal Reserve Chair Janet Yellen, in February. Powell as good as confirmed that the US interest rates would rise at the meeting in December. Furthermore, Powell hinted that deregulation could be necessary in the banking industry. Such a move would improve the ease of doing business by removing regulation which interferes with firms’ ability to compete. Deregulation would be good news for banks’ business which is why banking stocks move higher on the hopes of it becoming a reality. 

4. Improved outlook in UK 

The UK taking a step closer to tying up the Brexit Bill is also supportive for US banks. Many of the big banks have a large footing in the UK. Signs of the UK and the EU moving towards trade deal talks could ease concerns for these banks. 

5. Interest rate hike concerns? 

Perhaps the downside for banks in the unclear picture over the path of interest rate hikes. Whilst the US economy is booming, and unemployment is historically low, inflation is still refusing to tick higher. PCE, the Fed’s preferred measure of inflation remained steady at 1.4% in October, still some way off the Fed’s 2% target. Investors remain unclear as to how hawkish the Fed will be in 2018 when weighing up strong economic growth against weak inflation. Higher interest rate environments are more beneficial to the business of banks. Therefore, signs of a less hawkish Fed could keep any banking sector rally capped.