Financials Up as Investors Gain Confidence on Fed's Discount Rate Increase

NEW YORK — Financial stocks turned around as investors gained confidence about banks after the Federal Reserve's discount rate increase.

"I think people are beginning to think rationally about what the Fed did," Rochdale Securities analyst Dick Bove said, as they understand it's "not a precursor to an immediate set of rate increases."

Bank of America Corp., which had been one of the worst performers in the Dow Jones Industrial Average earlier in the session, was recently up 10 cents, at $15.98. Other big banks were also up slightly, with Goldman Sachs Group Inc. rising 87 cents to $156.60 and Morgan Stanley increasing 7 cents to $27.33.

Regional banks got a boost as well, with State Street Corp. gaining 4.4% to $47.24, Zions Bancorp rising 3.8% to $18.40 and Fifth Third Bancorp increasing 2.4% to $12.21.

The Fed surprised investors shortly after Thursday's close by raising the rate it charges banks for emergency loans by a quarter-percentage point to 0.75%. While the move was generally expected, most market watchers didn't anticipate that the central bank would begin to implement its exit strategy so soon.

Federal Reserve Bank of New York President William Dudley said Friday, "The action yesterday was really an action about the improvement in banks" and said the institutions no longer need that emergency source of cheap funding the way they did during the depths of the financial crisis.

Dudley said the discount-rate increase doesn't mean the beginning of monetary-policy tightening.

Bove said the move doesn't affect most of the U.S. banks because you have to be borrowing from the discount window to be affected by the rate move.

The likelihood of an increase in interest rates at a time when inflation hasn't picked up and the economy isn't yet on a sustainable path is pretty minimal, he said.

Motley Fool senior analyst James Early said Friday morning's consumer price index data probably helped investors figure out the Fed's move. Since inflation is clearly not a concern, the market "has more faith that the Fed is just unwinding a special lending facility" rather than trying to make changes to monetary policy, he said.

Data from the Labor Department showed U.S. consumer prices barely rose in January and core inflation fell for the first time since 1982, which leaves scope for the Fed to continue supporting the economy with record-low interest rates.

The discount window has traditionally been a lender of last resort, Early said, and now it's getting back to that.

Bove said when the Fed does increase rates, it will be at a moderate pace, and he doesn't think interest rates will get back to 3% until 2013. It's not looking at monetary tightening or rate increases, he said, but is saying the financial system has returned to health, and that bank loan-losses are going to go down, which will drive earnings up and stocks to follow.

"Once people got past traders with knee-jerk reactions last night and this morning, and started thinking about what the Fed did, they began to realize the Fed is saying the environment is much better for banks to make money," he said.

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