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Janet Yellen Says Interest Rates Could Rise "Relatively Soon"

Image source: iStock/Thinkstock.

The good news keeps rolling in for banks. On Thursday, the chairwoman of the Federal Reserve, Janet Yellen, told Congress that an interest rate hike "could well become appropriate relatively soon."

Interest rates are the single most important variable for investors in bank stocks to watch right now. It's why I've talked ad nauseam about the issue for much of the past year, as the most widely held bank stocks -- JPMorgan Chase (NYSE: JPM), Bank of America (NYSE: BAC), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC) -- all stand to profit handsomely once rates increase in earnest.

Indeed, the most likely reason to explain why all four of these stocks climbed on Thursday was Yellen's testimony.

Bank

Thursday (11/17) Stock Performance

JPMorgan Chase

0.65%

Bank of America

1.64%

Wells Fargo

1.72%

Citigroup

1.71%

Data source: Yahoo! Finance.

Three reasons Yellen is optimistic

Yellen focused on three specific things in her remarks to Congress, the first being the rosy jobs picture. The unemployment rate stayed at 4.9% in October, which continues to be below the Fed's definition of maximum employment, defined as an unemployment rate of 5%.

The Fed chairwoman noted that the rate of jobs growth continues to be "above trend" and that the labor force participation rate has remained constant despite headwinds from an aging population -- which, holding all else equal, causes labor force participation to fall as retirees exit the workforce.

But the best sign on the employment front in the United States right now relates to jobless claims. The latest data, released Thursday, shows that the number of Americans applying for first-time unemployment benefits dropped to the lowest level in more than four decades. You have to go back to 1973 to see a comparable level.

Data source: Federal Reserve Bank of St. Louis. Chart by author.

Yellen also found economic growth data to be a positive sign. Although output grew at just 1% for the first six months of 2016, it's estimated to have nearly tripled to just under 3% in the third quarter. It did so in spite of the ongoing concerns about the integrity of the European Union and moderating growth in China.

Last but not least, the one area that monetary policymakers continue to watch for improvement is inflation. And while the most recent data shows that inflation remains below the Fed's 2% target rate -- it came in at 1.6% in October -- the trend in consumer prices is heading in the right direction as well.

Data source: Federal Reserve Bank of St. Louis. Chart by author.

This is the variable, in turn, that investors in JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup should watch most closely. The higher inflation goes, the more likely the Fed is to raise rates and thereby boost the amount of money that each of these banks earns from their multibillion-dollar portfolios of loans and securities.

On the low end, Citigroup and JPMorgan Chase will earn between $2 billion and $3 billion in added net interest income each year from a 1-percentage-point increase in rates. On the high end, Bank of America's net interest income would climb by $5.3 billion under the same scenario. (Wells Fargo's disclosures around interest rate sensitivity are less specific.)

With this in mind, Yellen's comments about a possible rate hike coming soon should be music to bank investors' ears. According to the Fed chief, at the latest meeting of the committee in charge of monetary policy, its members "judged that the case for an increase in the target range had continued to strengthen and that such an increase could well become appropriate relatively soon."

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John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool owns shares of Wells Fargo. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.