Bank ETFs Benefit From Steepening Yield Curve, But How Long?

Bank ETFs have underperformed the S&P 500 this year and in the past one-year frame. SPDR S&P Bank (NYSE:KBE) ETF KBE was down 13.6% in the past year versus 3.5% gain of the S&P 500.Meanwhile, KBE is up 14.4% year to date compared with 18.8% rise in the S&P 500. A flattening yield curve caused the underperformance. In fact, some parts of the yield curve inverted at times this year (read: Fear an Inverted Yield Curve? Short Financial Stocks With ETFs).

Yield Curve Steepened Now

Since banks borrow money at short-term rates and lend capital at long-term rates, steepening of the yield curve bodes well for bank ETFs.

The yield on the 10-year U.S. Treasury was 1.63% on Sep 9, up from 1.47% recorded at the start of the month and 1.55% on the previous day. Meanwhile, yield on three-month treasury yield dropped to 1.96% on Sep 9 from 1.98% noted on Sep 3. The spread between two- and ten-year-treasury-yield was zero on Sep 3. And on Sep 8, the spread became 5 bps.

Actually, the movement of short-term bonds is more dependent on Fed behavior than long-term bonds. The Fed has already enacted one 25-bp rate cut this year and may slash rates further this year, thanks to rising slowdown fears owing to the U.S.-China trade tensions and global growth worries.

Meanwhile, reports of a meeting between the United States and China in October boosted risk-on sentiments, which in turn provided a boost to the broader market. This contributed to the rise in long-term bond yields on Sep 9.

Other Tailwinds

In June, most of the U.S. banking biggies cleared the key Stress Test conducted by the Federal Reserve. The test reaffirms big banks’ ability to endure severe economic crisis. Goldman Sachs (NYSE:GS) , J.P. Morgan Chase (NYSE:JPM) , Bank of America (NYSE:BAC) , Wells Fargo (NYSE:WFC) , Citigroup (NYSE:C) and Morgan Stanley (NYSE:MS) announced a volley of dividend hikes (read: Big Banks Clear Fed's Stress Test, ETFs Rally).

Market Reaction

Most of the big banks’ shares jumped on Sep 9.Bank of America Corporation (up 3.3% on Sep 9), Goldman Sachs Group (up 2.3%), Citigroup (up 4.3%), KeyCorp (NYSE:KEY) (up 5.2%) and Morgan Stanley (MS) (up 2.2%) — all gained in the key trading sessions.

Among ETFs, the gainers were KBE (up 3.4%), Invesco KBW Bank ETF KBWB (up 3.6%), Invesco KBW Regional Banking ETF KBWR (up 3.4%), iShares U.S. Financial Services ETF IYG (up 1.3%) and Financial Select Sector SPDR Fund XLF (up 1.5%).

Is There Any Glitch?

While sailing looks smooth for the near term, tensions related to trade is still rife. The year 2020 could be volatile enough to drag down long-term bond yields due to the presidential election in November, Brexit outcome and conditions of the global economy.

Speaking at an industry conference, Citigroup Inc and Wells Fargo and Co slashed their outlooks for net interest income, citing macroeconomic concerns, per Reuters. Wells Fargo is highly interest-dependent as “it manages rate-sensitive deposits and mortgage securities. More than half of Wells Fargo’s loan portfolio carries variable interest rates, with the majority linked to industry benchmarks which have largely fallen in recent months.” So, investors should be careful about investing in bank ETFs if they have a long-term view.

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