Investors in financial services stocks and exchange traded funds, such as the Financial Select Sector SPDR (NYSEArca: XLF), have been patiently waiting on a rate hike from the Federal Reserve.
That has not happened since last December and that was merely the first time in over a decade the Fed boosted borrowing costs.
With Fed funds futures indicating there is a 94% chance the Fed raises interest rates by 25 basis points when it meets next week, rate-sensitive bank stocks and ETFs are in focus after soaring for the past month following the surprising presidential election results.
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.
Heading into this year, many market observers expected four Fed rate hikes, a number that subsequently dropped to two and now, in the eyes of some experts, zero. 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.
The other side of the coin is that Fed disappointment could mean a nasty retrenchment for ETFs such as XLF.
“Bank stocks are heavily reliant on the bond-yield environment, and as the perceived odds of the Fed raising rates next week have risen, the banks have gotten a big boost. (BK Asset Management’s Boris) Schlossberg warns that rather than raise rates over and over again, ‘the Fed could simply do the one and done,’ hiking in December and then choosing to ‘sit for the next six months,’” reports CNBC.
Regional bank ETFs have also been soaring in anticipation of higher rates. SPDR S&P Regional Banking ETF (NYSEArca: KRE) is the largest, most heavily traded regional bank ETF, is up more than 16%.
KRE has been thirsting for higher interest rates. The same goes for rivals such as the iShares U.S. Regional Banks ETF (NYSEArca: IAT) and PowerShares KBW Regional Bank Portfolio (NYSEArca: KBWR), which both include greater tilts toward smaller banks.
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.