Funds that track bank stocks are having a great week as bond yields climb and the difference between the rate investors demand for shorter versus longer-duration bonds steepens.
The SPDR S&P Bank ETF /zigman2/quotes/201006419/composite KBE -2.27% is up more than 6% this week, while the First Trust Nasdaq Bank ETF /zigman2/quotes/204254219/composite FTXO -2.02% and the iShares U.S. Regional Bank are both up nearly 6%, beating a 0.5% weekly gain for the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.48% and 0.6% for the Dow /zigman2/quotes/210598065/realtime DJIA -0.07% .
Banks make money when there’s a bigger spread between short-term interest rates, which they pay for deposits, and long-term rates, which they receive for lending. That spread gets bigger when investors expect faster economic growth and smaller when they expect slower.
When the yield curve inverts, it means borrowers expect to pay a higher interest rate for short-term debt than long. That’s often a sign of something askew in the economy, like a possible government debt default or the possibility of a recession.
The U.S. Treasury yield curve has been mostly inverted since May this year, and it has investors watching the bond market nervously. Many analysts believe it’s one good reason for the Federal Reserve to cut short term interest rates. The Fed has leverage over shorter-term debt, so nudging those yields down could force the entire curve to steepen.
After soaring higher over the course of the summer, bonds have sold off over the past week or so, pushing yields back up at the longer end of the curve, possible to the benefit of bank earnings.
On Tuesday, technical analyst Chris Kimble noted that a closely-tracked ratio of bank stocks /zigman2/quotes/210598427/realtime BKX -2.24% to the S&P 500 recently hit a technical support level, causing a “small rally.”
“Is the bad news for banks stocks about to end?” Kimble asked. “Stock market bulls sure hope so, as the stock market tends to be on stronger footing when the banks provide market leadership.”
But there are plenty of analysts who think we’ve been here before in the long economic recovery: a good stretch for banks, followed by “lower for longer” earnings and even stock prices. Big banks including Citigroup /zigman2/quotes/207741460/composite C -2.54% and JPMorgan Chase & Co. /zigman2/quotes/205971034/composite JPM -2.55% have told investors to expect less net interest income - revenue that comes from the widening yield curve, noted above - in the coming quarterly earnings releases.