Changes in Fed Rates Will Weigh on Financial Stocks, ETFs

Many have pointed to changes in long-term interest rates as a major selling point for the financial sector and related ETFs, but there is more to the picture.

The financial sector has enjoyed a good run as yields on long-term debt increased, but the good times are starting to peter out as the Federal Reserve tightens its monetary policy. The Financial Select Sector SPDR (NYSEArca: XLF), the largest  financial services-related ETF, has dipped 1.5% year-to-date while the S&P 500 rose 5.2%.

David Ranson, director of research at financial-research firm HCWE & Co., argued that bank stocks have been more historically sensitive to changes in short-term rates than long-term rates, the Wall Street Journal reports.

Looking at annual data from 1989 through 2015, Ranson found bank stocks rallied 14.2% on average in the two years following cuts in the fed-funds rate, compared to the average 7.4% gains in the two years following a hike in the fed-funds rate. Additionally, while bank stocks increased 11.5% in the two years after yields declined, the sector saw 10.5% gains in the two years following an increase in yields.

Furthermore, loan volume and interest rates paid to depositors also play a role in a bank’s bottom line. Banks boost profits by increasing loans even if profit margins are low.