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JP Morgan: Probable Interest Rate Hike In September
Aspire, Hot Picks, Investments | 03 July 2015
By: Lim Si Jie
Articles (169) Profile

The Fed policy statement released last Wednesday signalled to the market that near-zero percent rates are on track to move higher for the first time since 2006. JP Morgan believes that all these are signs that point towards a rate hike sometime this year.

Although the Fed said in its statement that economic activity is improving, the outlook for Gross Domestic Product (GDP) growth in 2015 shifted to 1.8 to 2 percent, from 2.3 to 2.7 percent.

The weaker outlook meant that the country’s gross domestic product is not as robust as the labour market seems to suggest.

Cautious Fed To Be Data Driven

Fed Chairman Yellen and her team highlighted that progress in economic development will be the deciding factor in future decisions regarding fund rates.

While the Fed maintains its main objectives of achieving maximum employment and a target inflation rate of two percent, the debate on Wall Street is focused on whether the first increase would be in the September or December meeting.

According to JP Morgan, the Federal Open Market Committee (FOMC) was very careful to make its latest projection a super-soft signal for rate hikes in September. JP Morgan believes that the Fed’s decision will depend heavily on US’s financial data.

That being said, JP Morgan is still putting their money on a rate lift-off in September, albeit with “less conviction” after the latest Fed projections. JP Morgan notes that if the employment figures and data in May continues to impress in the upcoming months, the Fed would most likely have the first rate hike in September.

Interest Rate Hikes To Accelerate After First Lift-Off

Two percent was the “normal” accommodative interest rate before the 2009 financial crisis. JP Morgan forecasts that the Fed could increase key short-term interest rate to as much as two percent by the end of 2016.

In order for interest rates to get as high as two percent, the Fed will likely accelerate its rate hikes after the first interest rate hike. This means that the Fed could raise rates “every other FOMC meeting” once the tightening cycle begins.

The Fed is also watching international events as it makes decisions. In the past, The Fed acted as if overseas markets shouldn’t be included in its calculations.

However, with the sticky situation in Greece, where the European government may face an unprecedented default of a developed nation, it could cause real chaos that could even spill into the rest of Europe and the rest of the world, including the US.

Banking Stocks To Benefit

The financial sector is one of the main beneficiary from rising interest rates.

The banking sector will benefit from rising interest rates as their interest margins increase, creating more profit. Rising interest rates also mean that the economy is recovering healthily, which generally means a greater demand for loans.

Using a two-stage Dividend Discount Model (DDM) analysis, JP Morgan based its $12.00 valuation for OCBC on a fair Price-Book Value of 1.41x with a normalised Return on Equity (RoE) of 12.4 percent, risk-free rate of 3.5 percent, cost of capital of 9.5 percent, and growth rate of 2.5 percent.

OCBC: Overweight, TP $12.00

DBS is arguably the leader in digital banking initiatives in the region. The bank has been consistently building towards a more organic growth in markets like India and Indonesia on the back of its digital capabilities.

DBS: Overweight, TP $22.00

Higher rates would have a very different impact on UOB’s earnings compared to its peers. A move of 100 basis points in interest rates would lead to net interest income rising by $300 million to $400 million. However, credit costs will increase by $180 million as debt servicing burden for borrowers increase too.

UOB: Underweight, TP $22.50

Other than banking stocks, the dollar index (DXY) can also be a good investment to add to one’s portfolio to ride on the dollar’s sensitivity to rising interest rates.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

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