Investors may lose interest in financial sector-related exchange traded funds in the short-term as the Federal Reserve hikes interest rates and the yield curve flattens out.
For instance, the Vanguard Financials ETF (NYSEArca: VFH) experienced almost $160 million in net outflows Tuesday and saw $156 million exchange hands on Wednesday, or more than triple the average daily volume for the past year, report Carolina Wilson and Sarah Ponczek for Bloomberg.
Falling longer-term yields hurt bank profits since it narrows the spread banks can earn between their longer-term assets that are funded with shorter-term liabilities.
Bank Profits Squeezed
“Banks generally borrow short and they lend long,” Mark Hackett, chief of investment research at Nationwide Funds Group. “So the fact that the 10-year is really not moving while the short end is moving higher will actually temporarily choke off some of the net interest margin.”
Yields on benchmark 10-year Treasury yields are hovering around 2.94%. Meanwhile, yields on 2-year notes are now at 2.57% and yields on 12-month notes are at 2.31%.
Looking ahead, the Federal Reserve said it was comfortable with hiking interest rates at least two more times later this year after announcing its second rate hike this year.
The announcement “is not a good scenario for financials,” Mike O’Rourke, JonesTrading’s chief market strategist, said in a research note. “Although the algorithms have been trained over the past three years to buy financials on the hopes of higher rates and a steeper curve, that opportunity has largely been missed.”
Over the three-years, VFH generated an average 13.8% annual return, compared to the S&P 500’s 12.2% average gains. Year-to-date, VFH is up 1.3% while S&P 500 was 4.7% higher. VFH is also testing its short-term trend line at the 50-day simple moving average.
For more information on the banking sector, visit our financial category.