Treasury yields have on the rise, indicating that investors are pricing in an imminent rate hike by the Federal Reserve.
The widely held belief is that the Fed will raise rates for the first time this year following its December and that speculation is benefiting predictable group of exchange traded funds.
The Financial Select Sector SPDR (NYSEArca: XLF) is higher by nearly 3% over the past month. With a steepening yield curve, or wider spread between short- and long-term Treasuries, banks could experience improved net interest margins or improved profitability as the firms borrow short and lend long.
The rate hike outlook has swiftly changed in recent weeks with some bond traders seeing it as almost guaranteed a rate hike will come in December, which would be a boon for ETFs like XLF.
Related: Financial Sector ETFs Maintain Momentum
Higher interest rates would help widen the difference between what banks charge on loans and pay on deposits, which would boost earnings for the financial sector. Regional banks are among the stocks most positively correlated to rising interest rates because higher rates improve net interest margins. The SPDR S&P Regional Banking ETF (NYSEArca: KRE) is up more than 4% over the past month.
“Now how sustainable is this move? I think it is pretty sustainable to be honest and it is because of the chart below. This is the 10 year yield all by itself. It now sits at 1.84%, the highest since June. The chart looks very similar to the financial charts above because as rates rise the natural perception of investors is that banks will benefit too,” according to See It Market.
[related_stories]With a steepening yield curve, or wider spread between short- and long-term Treasuries, banks could experience improved net interest margins or improved profitability as the firms borrow short and lend long.
SEE MORE: Bank ETFs Could Shine in Q4
The recent strength displayed by U.S. bank stocks is impressive as it comes at a time of notable weakness for European banks. The iShares MSCI Europe Financials ETF (NYSEArca: EUFN) is one of this year’s worst-performing non-leveraged sector ETFs. Market observers have warned that the ongoing monetary polices and depressed rates would weigh on banks’ bottom line as firms would find it hard to make money with a flat yield curve – banks borrow short-term and lend long-term.
For the moment, it appears investors are more focused on the Fed when it comes to ETFs such as KRE and XLF and that is a good thing.
“So as long as the 10 year yield stays above the latest highs, I think betting on financials relative to the S&P 500 is not a bad idea,” adds See It Market.
For more information on the financial sector, visit our financial category.