Bank stocks are on pace for their best day in nearly two years as bond yields have tumbled in response to better-than-expected inflation data.
The
SPDR S&P Bank ETF
(ticker: KBE) was up 6.5% in midday trading, just a hair behind the exchange-traded fund’s 6.9% increase on Jan. 6, 2021. The jump comes after the Bureau of Labor Statistics said early Tuesday that the consumer price index climbed 3.2% in October—well below the increases of 3.7% in August and September, and a touch under the 3.3% expected by analysts surveyed by FactSet.
Understanding why that is good for banks requires a look at the Rube Goldberg-like machinery we call the financial system.
Cooling inflation means the Federal Reserve is under less pressure to keep interest rates higher for longer. Bond yields, which are tethered to what the Fed does, and what investors think it might do, declined in response. By midday, the yield on the 10-year Treasury note was below 4.5% after nearly touching 5% last month.
Higher interest rates are generally thought to help banks because they allow lenders to earn more on assets such as loans while keeping payments to depositors relatively low. But there is also the risk of too much of a good thing.
Deposits flooded into banks during the pandemic, but demand for loans was weak, so lenders invested in Treasury debt. Normally, that would be a safe move but the value of Treasuries plunged as the Fed raised rates to fight inflation, leaving banks with an aggregate $558 billion in unrealized losses.
Meanwhile, bank deposits dwindled as households and businesses spent down their pandemic nest eggs. Savers also realized that with rates climbing, they could actually earn more interest on their cash in money-market funds and other vehicles than by keeping it in bank deposits.
To keep deposits from draining away, banks have had to pay more to savers, eroding the margin they earn on loans.
With bond yields ticking lower, as they did Tuesday morning, bank investors are betting on a few things. The first is that the Fed won’t tip the economy into a recession, which would hurt loan demand and make it harder for borrowers to keep up with their payments. The second is that if bond yields can stay low, banks will feel less pressure on their balance sheets from unrealized losses on their Treasury investments. The third is that banks’ cost of funding, driven in large part by how much they have to pay depositors, will stabilize.
All that adds up to a badly needed jolt of good news for banks. Even after the Tuesday morning surge, the KBE is down 21% this year, while the
S&P 500
has climbed 13%.
Among some of the better bank performers Tuesday were
Citizens Financial
(CFG), which gained 6.9%; Fifth Third Bank (FITB), with a gain of 6.4%; and
M&T Bank,
up 5.9%.
Write to Carleton English at [email protected]
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