The following commentary originally was sent to Action Alerts PLUS subscribers on Dec. 16, 2015, at 3:07 p.m. ET.
The wait is over. After seven years of a zero interest rate policy, the Federal Reserve announced this afternoon that it is raising interest rates, increasing the target range of the federal funds rate by 25 basis points to a range of 0.25% to 0.50%. The decision, which investors all but expected, came as the Fed wrapped up its two-day Federal Open Market Committee meeting this afternoon and received unanimous support from all board members.
In its official statement, the FOMC continued to reiterate that future rate increases likely will be modest and gradual, and will take into account domestic and international developments. Officials cited incremental acceleration in household spending and business fixed-income investments as well as an improving housing market as positive indicators while acknowledging weakness in exports.
As we have discussed in the past, the Fed largely bases its monetary policy decisions on two leading factors: the health of the job market and the level of inflation. While officials expressed optimism around the labor market, citing ongoing job gains and declining unemployment, they maintained a tempered outlook around inflation, which has continued to run below the FOMC's 2% long-term target. Officials cited declines in energy prices and in prices of non-energy imports as deflationary pressures, yet expressed optimism over the medium term as the "transitory effects of declines in energy and import prices dissipate and the labor markets strengthen further."
Initial reactions have been mixed around whether the statement-- which fell almost perfectly in line with expectations -- should be considered dovish or hawkish. We await Chairperson Janet Yellen's comments before making a firm judgment. We do believe the announcement reaffirms the Fed's confidence in the economy, but have some reservation around persistently low inflation and the ability for inflation to reach the Fed's 2% target.
We view the announcement as relatively positive, albeit expected, for our bank stocks -- Bank of America (BAC) and Wells Fargo (WFC) -- which by far are the names most levered to interest rate moves. Indeed, Bank of America previously has stated that an increase in rates of 100 basis points (one percentage point) could boost net interest margin -- the most important financial bank metric -- by more than 11%. Wells Fargo quickly made the decision (immediately following the Fed's release) to raise its prime rate -- its general interest rate provided on loans -- by one-quarter point to 3.5% from 3.25%. Importantly, WFC and other banks have stated that they will not be applying this rate policy to their deposits. While unfortunate for savers who use those banks, this approach is beneficial for the banks themselves as they reap the benefits from higher rates on loans.
We also view the committee's optimistic commentary around the economy as positives for our retail names -- Costco (COST), Jack in the Box (JACK), Kraft Heinz (KHC), Mondelez (MDLZ), Panera Bread (PNRA), Starbucks (SBUX), Target (TGT), Walgreens Boots Alliance (WBA) and WhiteWave Foods (WWAV). In particular, the Fed's explicitly positive commentary and outlook around the housing market bodes well for Stanley Black & Decker (SWK). The rate hike is not a positive for our high-dividend names -- Energy Transfer Partners (ETP), Dow Chemical (DOW) and 3M (MMM) -- as the relative attractiveness of their yields diminishes, but we believe this discount has been well-baked into prices.