Investors heaved a sign of relief when both the Federal Reserve and the European Central Bank (ECB) indicated that they will take necessary steps to counter the effects of a decline in major European economies. While the Fed is willing to ease monetary conditions to stimulate the American economy if the need arises, the ECB stirred hopes of an interest rate cut while promising a continued source of funds to European banks.
This went a long way to ease investor sentiments which has been battered in recent weeks over fears that the economies of Spain and Italy are on the edge and threaten the euro. Bank stocks become overnight favorites among investors, showing some of the biggest single-day price gains this year. Shares of Morgan Stanley (NYSE:MS) and Barclays (NYSE:BCS) jumped by more than 8%, followed by a gain in value of 7.6% for Bank of America (NYSE:BAC) and 6.5% for RBS (NYSE:RBS). Citigroup (NYSE:C), UBS (NYSE:UBS) and Credit Suisse (NYSE:CS) saw their share prices rise by more than 5% at the stock market on Wednesday.
Three voting members of the Federal Reserve helped spread the cheer among investors when they expressed their support for another round of economic stimulus if the situation gets any worse. The members responsible were the Fed vice chairman Janet Yellen, and presidents of the Fed’s Atlanta and San Francisco regional banks Dennis Lockhart and John Williams respectively.  The steps they proposed include maintaining short term interest rates at the current near-zero level for the next two years, besides buying more bonds to push more cash in the economy and lower long term rates.
On the other hand, the ECB has been pondering over a cut in the interest rates to 0.75% to help coax more economic activity in the Eurozone. The central bank has also vouched to offer nearly unlimited cheap credit to European Union banks for the rest of the year.
Banks stand to gain the most from these moves by the Fed and ECB, as they normally borrow funds for a short period, and loan them out for long periods. Consequently, banks earn more from the loans they give out, as their net interest yields increase with falling short term interest rates.Notes:
- 3 Federal Reserve voting members say they would support more stimulus if economy weakens, Daily Journal, Jun 6 2012 [↩]