Citigroup Inc (NYSE: C) and the other "big four" U.S. banks all finished Wednesday's trading session in the red, giving up initial afternoon gains following the latest Federal Reserve interest rate hike.
Analysts say banks are getting diminishing returns on rising interest rates, but Citigroup is well-positioned heading into this month's Comprehensive Capital Analysis and Review stress test.
The Federal Reserve raised its benchmark short-term interest rate by 0.25 percent for the second time this year on Wednesday. In addition, the Fed's latest "dot plot" interest rate forecast suggested there could be two additional rate hikes coming before the end of the year.
"The impact for markets is that rate sensitive sectors such as etilities and real estate should be underweighted in favor of sectors that benefit from rising rates, such as financials," says Chris Zaccarelli, chief investment officer for Independent Advisor Alliance.
CFRA analyst Kenneth Leon says rising interest rates are typically good news for big banks like Citigroup. Higher rates allow banks to charge more interest on loans and increase their net interest margins. "We think that with wider lending spreads, the diversified banks are likely to boost growth," Leon says.
However, Bank of America analyst Erika Najarian says big banks are starting to get diminishing returns on higher rates.
"At this point in the tightening cycle, we do not think upside surprises to Fed hikes is as positive for [bank] stocks as it was in the beginning of the cycle," Najarian says.
She says the shape of the yield curve, the difference between short-term interest rates and longer-term interest rates, is much more relevant for bank stocks than current interest rates. Since the financial crisis, there is a 50 percent correlation between bank stock price-earnings ratios and the steepness of the yield curve, according to Bank of America. Correlation between bank P/E ratios and the current fed funds interest rate is just 12 percent.
Citi stock has struggled so far in 2018, down 9.5 percent year-to-date. However, Najarian says the bank is well-positioned for CCAR.
"C has matched the underperformance of beleaguered [Wells Fargo & Co. ( WFC)] this year, but we point out that the bank has the best ability to hit high capital return expectations," she says.
Bank of America has a "buy" rating and $84 price target for C stock.
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