Wells Fargo & Co (WFC), Citigroup Inc (C): A Mixed Blessing for Banks

But, as the economy improves, we’ll see interest rates start to move back up. We’ve already started to see some of that. We saw it rather drastically through the first part of this year. That will happen, just in terms of expectations that rates will go up, but those expectations play off of …

You know, the Federal Reserve has been taking some pretty drastic action to keep interest rates low. Part of that has been keeping their core interest rate between 0 and 0.25%. Then, in addition to that, they’ve been buying Treasuries, and they’ve been buying mortgage bonds to try to keep those rates low. Eventually, they’re going to stop doing that as they see the economy start to improve.

They’re triggering that off of a combination of inflation — they want to see inflation stay under a given level — and then also unemployment. They want to see unemployment come down. It’s called the Fed’s “dual mandate.” The dual mandate is to keep prices stable and to keep employment at what they call a “full” level.

What they’re looking at right now is they want to see unemployment go down to below 6.5%. At that 6.5% level, the Fed will start thinking about changing its core rate. But before that happens, they’re going to start tailing off these mortgage bond purchases and these other security purchases, and that will allow interest rates to start to move up.

I think we’re seeing expectations that are pushing those rates up ahead of that, and that’s creating some short-term pain for banks because they hold a lot of fixed-income securities, and when rates go up, prices of fixed income securities go down. When you hold billions of dollars of those on your balance sheet that hurts, short term.

Longer term, though, the higher rates will lead to higher spreads, the better economy will lead to higher demand for services, and I think, bigger-picture, that’s where the banks want to see things going.

The article Higher Interest Rates: A Mixed Blessing for Banks originally appeared on Fool.com is written by Matt Koppenheffer.

Matt Koppenheffer has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Citigroup and Wells Fargo.

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