Things were supposed to be better for regional bank stocks and the relevant exchange traded funds. On the back of the Federal Reserve’s first interest rate hike of 2017 and its third in 15 months with the stage set for more rate increases later this year, it would be reasonable to expect the rate-sensitive SPDR S&P Regional Banking ETF (NYSEArca: KRE) to be up more than 2.5% year-to-date.

Predictably, much of the bull case for regional banks depends on the Federal Reserve and interest rates. 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. Additionally, the Fed is hoping to raise interest rates as many as three times this year, an effort that could further support KRE and friends.

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.

However, the Fed assist has not really materialized for KRE this year.

“For some context, the regional banks as a group rose 21 percent in the month following the U.S. election in November. Regional banks differ from ‘big banks’ in the size of their operations and in the scope of their services, focusing on taking deposits, making loans and providing credit card services,” reports CNBC.

Politics are also boosting bank stocks. President-elect Donald Trump’s official transition website stated that the “financial Services Policy Implementation team will be working to dismantle the Dodd-Frank Act,” which was signed into law by President Barack Obama in 2010 to obviate another financial downturn. The law increased the burden of banks to safe guard against another meltdown event and forced many to greatly reduce exposure to riskier assets, which have also dragged on the financial sector’s bottom line.

Unfortunately for some that are bullish on the financial service sector, with the Fed looking dovish even after its recent rate hike, politics might be the lone remaining catalyst for the sector for a while and that could weigh on regional banks that were hoping for a more hawkish Fed.

Miller Tabak equity strategist Matt Maley “observed that the spread between the 2-year and 10-year U.S. Treasury notes has fallen from 1.35 percent to 1.19 percent since late December. And if the curve flattens further, “the group could break-down,” according to CNBC.

For more information on the banking 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.

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