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U.S. bank stocks continue to rocket higher along with long term interest rates. The steepness of the U.S. yield curve – the difference between two-year and 30-year mortgage rates – remains the best indicator of short term American bank stock performance. The potential for reduced central bank monetary stimulus is a new, and potentially positive, wrinkle for investors in the sector.
Concerns regarding the end of Federal Reserve-led monetary stimulus have combined with signs of a strengthening U.S. economy to drive 30-year U.S. Treasury yields sharply skyward. The yield on the 30-year bond jumped almost 100 basis points between April and August this year.
The two-year bond yield rose a mere eight basis points for the same period. As a result the U.S. yield curve is now markedly steeper than four months ago.
Banks – who borrow funds at short term rates and lend them out at higher, longer term levels – are among the biggest beneficiaries of a steeper yield curve. So its not a huge surprise that the KBH U.S. Bank Index has tracked the steepness of the Treasury yield curve (which we measure in this case as the difference between the yield of the 30-year bond and that of the two-year) with a correlation of 0.94. (see chart)
U.S. bank investors will have the most at stake – and possibly most to gain – when the Fed begins withdrawing monetary stimulus, although much of the damage may already be priced in. If the U.S. yield curve steepens even further when the Fed reduces its asset purchase program, and the Evans Rule holds (that there will be no rise in short term rates until the unemployment rate falls further), bank stocks are likely to climb.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .