Despite calls for higher interest rates, a flattening yield curve could diminish the profitability for the banking industry and weigh on financial stock-related exchange traded funds.
Year-to-date, the Financial Select Sector SPDR (NYSEArca: XLF), which includes a 36.0% tilt toward the banks sub-sector, has increased 12.5%, while the SPDR S&P Regional Banking ETF (NYSEArca: KRE) was up 0.2% and the SPDR S&P Bank ETF (NYSEArca: KBE) was 0.7% lower.
Once the Federal Reserve eventually hikes rates, yields and bank net-interest margins would move back toward normal levels, which would help provide a nice boost in bank valuations, writes David Reilly for the Wall Street Journal.
Short-duration bonds and money market funds have already seen yields rise, suggesting that the markets are pricing in higher rates ahead. Despite dipping slightly over the past few days, short-term U.S. interest rates remain at or above year-ago levels, with 2-year Treasury yields at 0.61%. [Short-term, Money Market Bond ETFs Reveal Rising Rate Expectations]
However, long-term yields have dipped, with benchmark 10-year Treasuries falling below 2% Tuesday to as low as 1.889%. Dragging on long-term yields, foreign central banks are engaging in monetary easing, which has pushed investors into more attractive income-generating assets like U.S. Treasuries. [Investors Can’t Get Enough of Treasury Bonds, ETFs]
“The buying has been orderly and there has been demand from investors including some deep-pocket foreign central banks and money managers.” Jason Rogan, managing director of US government bond trading at Guggenheim Securities LLC. said in a Wall Street Journal article.