The Federal Reserve raised its benchmark federal funds rate by 0.25% to a target range of 3.75% to 4.00% on September 16, marking its first rate hike since 2023. The move immediately weighed on U.S. bank stocks, raising fresh questions about whether higher borrowing costs could affect economic growth, loan demand, and credit quality.
The BMO Equal Weight US Banks Index ETF (TSX: ZBK) fell about 1.2% following the announcement. The exchange traded fund (ETF) provides exposure to 23 U.S. banks, with each holding representing more than 4% of the portfolio. Its equal-weight approach reduces dependence on any single bank, although the fund remains vulnerable to interest-rate changes, economic weakness, and potential credit losses.
Source: Official White House photo by Daniel Torok
Why Canadian bank stocks have held up
Canadian bank stocks have been more resilient. The BMO Equal Weight Banks Index ETF (TSX: ZEB), which holds Canada’s Big Six banks in equal proportions, gained roughly 0.8% since the Fed rate hike announcement. The ETF also provides monthly distributions, making it popular among income-oriented investors.
One reason for the relative stability could be that the Bank of Canada left its policy interest rate unchanged at 2.25% on September 2. Canadian banks therefore avoided an immediate rate-related dip similar to the one experienced by their U.S. counterparts.
However, that stability could prove temporary. If the Bank of Canada follows the Federal Reserve with a rate hike at its October 28 meeting, Canadian financial stocks could face renewed selling pressure. Further increases could amplify concerns about household debt, mortgage affordability, economic growth, and potential credit losses.
Are the Big Six too expensive?
Valuation is another reason investors may want to be selective rather than chase the recent strength in Canadian bank stocks.
Royal Bank of Canada, for example, trades at a blended price-to-earnings (P/E) ratio of approximately 17.8, around 45% above its 10-year average. Canadian Imperial Bank of Commerce trades at roughly 15.3 times earnings, about 50% above its 10-year average.
When shares become more expensive, their dividend yields generally fall unless earnings and payouts rise sufficiently to compensate. ZEB’s yield has already declined below 2.4%, reducing the income appeal compared with periods when Canadian bank valuations were lower.
That does not mean the Big Six are unattractive long-term investments. Canada’s major banks have substantial franchises, diversified businesses, and long histories of returning capital to shareholders. But paying a premium valuation can leave less room for error if interest rates rise and remain elevated or earnings growth disappoints.
For Canadian investors considering adding bank stocks, patience could therefore be valuable. Rather than buying aggressively after a period of strong performance, investors may want to watch the Bank of Canada’s October decision and subsequent guidance. A clearer interest-rate outlook, combined with more attractive valuations, could provide a better opportunity to build or add to positions in the Big Six.
The bottom line
The Federal Reserve’s latest rate hike has pressured U.S. bank stocks, while Canadian banks have remained relatively resilient. However, elevated valuations and the possibility of rate increases could limit near-term upside for the Big Six. For Canadian investors, waiting for greater clarity on interest rates may be the more cautious approach.
