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- With the Fed on hold, and perhaps indefinitely if inflation does not pop again, we see opportunity to go long interest-sensitive sectors that were beaten down by the prospect of 10-year Treasury rates rising above 5%.
- Recent earnings reports show regional banks and homebuilders continue to exhibit strong underlying fundamentals.
- With rate pressure relenting for now, we expect those fundamentals to reassert themselves.
- We like holding the regional bank ETF KRE and the homebuilder ETF (XHB).
When we said in our last note that equities will likely rally on signs the Fed is done or might soon relent, we were thinking coming weeks or months, not days.
Well, that day may be here. In leaving rates on hold at its latest meeting, the Fed said that tighter financial conditions and modest moderation in the labour market appear to be helping to slow inflation to its 2% target – although it left the door open to further rate increases.
This is in line with our view that the Fed may talk a hawkish line, but its actions err on the side of dovish.
The 10Y yield dropped 17 basis points to 4.71%, and interest-sensitive ETFs that track regional banks (KRE) and homebuilders (XHB) rallied (Chart 1).
Recent earnings reports suggest underlying fundamentals for both sectors remain strong. Regional banks have not experienced the worst that many expected after the Silicon Valley Bank collapse (e.g., deposit outflows, rising credit losses). And homebuilders continue to be profitable despites high mortgage rates. They sold off in recent weeks primarily because of fears of what further increases in rates might do in coming months.
For aggressive investors, we like to take long positions in KRE and XHB. We view this as a technical trade for now.