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Watch the banks if Fed doesn't cut

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While the bulk of market participants fully expect the FOMC to cut fed funds by 25-basis points at 02:15 PM EST, and some are calling for a 50-basis point cut for good measure, banking sectors are now today's sector loser with the more regional S&P Banks Index (BIX.X) 286 -1.53% and more money center KBW Bank Index (BKX.X) 770 -1.49% both trading lower.

I believe this action is taking place as some sector bulls take some gains off the table just in case the Fed gets aggressive with a 50-basis point cut, which would squeeze margins at banks that are making loans as interest rates fall.

However, I also believe that the FOMC would only lower interest rates as a psychological boost for investors, and not necessarily because the economy lacks money supply. The past 11 Fed cuts have been very accommodative. I personally don't feel it is that interest rates being too high that have corporations hesitant to spend, but a still rather stagnant economy and pressures from Wall Street to push profits to the bottom line that had corporations less than willing to spend.

Should the fed "surprise" the market with no change in interest rate policy, then I would expect the broader equity market to spike lower on a short-term basis.

If so, then the broader type selling would bring most equities down, including the banks, but that may then provide the "best" bullish equity group for bulls to be looking to buy on the dip.

Thinking here becomes.... "hey, if they're selling the banks ahead of a potential 25 or 50-basis point cut, then the lack of a cut should actually be viewed rather favorable."

One stock I traded bullish back when the BIX.X broke above 250 on October 11th was shares of super-regional bank Wells Fargo (NYSE:WFC) $48.41 -3.14% from the $46 level. I got out a little too early on the stocks rise to $51.44, but saw a nice gain. The stock is once again under some selling pressure, but I'm looking for a little dip back to $47 and a new entry point.

Wells Fargo Chart - Daily Interval

In early October, we talked in great detail in our Index Trader Wraps at OptionInvestor.com that the banks would be a key sector to look for bullishness to signal a pending rebound in the broader markets. While I didn't trade an index trade in the BIX.X, I did like WFC as a bullish trade as it was a stock that showed good relative strength versus the group and unlike the bank indexes, had NOT tested an old low and showed some commitment from institutions. A trade back near $47 should the fed only cut rates 25-basis points or NO cut in rates is a spot where I'd look for bullish entry. Bulls can REDUCE risk in a bullish trade with the WFC January 45 calls (WFCAI), which are currently offered $4.90 and I'd expect a decline to $47.00 to have them offered about $3.90. Bullish target would then be $51 on or before expiration.

Jeff Bailey

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