The US banking sector continues to outperform the broader market. Furthermore, for the first time this year, regional bank shares are outperforming the overall bank index, which is driven primarily by the largest banks.
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| Red = S&P500; Green = S&P total banking sector index ETF; Blue = S&P regional banks index ETF |
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The key reason for the strong performance among US banks remains the steepening treasury curve. Banks pay next to nothing on deposits while charging a rate that is often linked to treasuries on the loans they make. The steeper the curve, the wider the “margin”. And given the leverage inherent in the banking system, even a small margin increase materially improves the return on equity.
The treasury curve has been steepening sharply in recent weeks – as seen from the spread between the 10y and the 2y yields (as well as 30y and 2y).
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What’s driving this steepening? Historically, rising longer dated bond yields were caused by higher inflation expectations. That’s not the case this time around. In fact as the chart below shows, longer-term inflation expectations have been declining.
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| Dow Jones Credit Suisse 10-Year Inflation Breakeven Index |
The rise in yields is instead mostly driven by higher expectations of earlier and faster reductions in securities purchases by the Fed. In particular, some at the Fed have been happy to see a bit of stabilization in monthly payrolls growth (at around 200K).
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The sustainability of this trend is yet to be proven, but combined with better GDP figures (see chart) and improved new home sales (see chart), these data may be sufficient to push even this dovish FOMC into launching its exit sooner than expected. The fact that corporate spreads are at the levels not seen since 2007 (see post) doesn’t help the case for maintaining the current pace of QE either.
