ETF Trends
ETF Trends

Exchange traded funds tracking the financial services sector, the second-largest sector allocation in the S&P 500, continue to climb higher and the Federal Reserve continues to be a big reason why.

On Wednesday, the Financial Select Sector SPDR (NYSEArca: XLF), the largest financial services exchange traded fund, rose to its highest levels in nearly a decade as traders speculated the Fed will raise interest rates at its meeting later this month. Previously, some bond traders reduced wagers the Fed was heading toward a March rate hike, instead eyeing May and June as the times for the Fed’s first rate increases of 2017.

Bank ETFs are benefiting from speculation that the Federal Reserve will boost interest rates multiple times this year. 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.

XLF is coming off one of its best annual performances since the global financial crisis. While the financial services sector, the second-largest sector allocation in the S&P 500, has some doubters after last year’s impressive rally, some market observers believe the sector can keep tracking higher this year.

“Higher rates are a tailwind for financial stocks, in large part because of bank net interest margin, or the difference between the interest they earn on the loans they make and the interest they pay out. Higher interest rates can boost net interest margins, which can lead to higher earnings,” reports Ryan Vlastelica for MarketWatch.

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 Fed is believed to be targeting three rate hikes in 2017 while Fed funds futures data currently imply the U.S. central bank will boost borrowing costs twice this year.

Wednesday’s “move in financial ETFs only extended their recent advance. The Select Sector fund, the largest ETF to track the space with $25.3 billion in assets, is up more than 40% over the past 12 months. In addition to growing expectations for higher rates, the industry has also been supported by the prospect of lower regulations under President Donald Trump. Financials have comprised the bulk of the overall market’s postelection move,” according to MarketWatch.

For more information on the financial sector, visit our financial category.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.