Bank shares hit as Treasury yield curve flattens

An important measure for US bank profitability plumbed an eight-month low on Tuesday, pressuring the shares of lenders and highlighting doubts in the bond market over the prospect of an acceleration in the economy and inflation this year.

The difference in yield between two and 10-year Treasury notes narrowed 2.5 basis points to 84.99 bps, the lowest level since October 3, according to Bloomberg data.

This closely watched relationship climbed to a post-election high of 135.5bp in late December, predicated on President Donald Trump’s pro-growth policies boosting inflation and sparking higher interest rates in the future.

With the Trump administration facing hurdles passing tax reform and higher infrastructure spending through Congress, investors have dialled back expectations for expansive fiscal policy.

Economic data has also been mixed since the start of this year, highlighted by a lack lustre jobs report for May and an easing in core inflation to an annualised rate of 1.5 per cent, well below the central bank’s 2 per cent target.

“In spite of well-wishers, the US economy and the Trump fiscal package may disappoint market expectations,” said John Hermann, an interest rate strategist at MUFG.

While the bond market expects the Federal Reserve will tighten policy at its meeting next month, the pace of further rate increases is seen being muted, supporting a flattening of the yield curve.

“This is late-cycle stuff and no wonder why the yield curve spread continues to shrink,” said Peter Boockvar, chief market analyst at The Lindsey Group.

Banks are particularly sensitive to the shape of the yield curve because they borrow short-term and lend over longer periods.

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Net interest margins, an important profitability metric, have been depressed for an extended period. After the election, analysts hoped the steepening yield curve would be a boon to margins, something that helped to send bank shares ripping higher.

The closely watched KBW banks index shot up by a third from the election to the start of March, only to have subsequently receded by 10.6 per cent. The index was down 0.8 per cent at midday on Tuesday.

Bank of America, which is considered to be more sensitive to yields than it peers, illustrates the shift in sentiment on Wall Street. The shares surged by 50 per cent from November 8 — March 1. But they have since tumbled 13.2 per cent, including a 1.2 per cent fall on Tuesday.

Other large banks were also under pressure on Tuesday. Wells Fargo shed 0.75 per cent, Citigroup dropped 1.1 per cent and JPMorgan Chase declined 0.43 per cent.

The decline in financials has also hit small-cap indices like the Russell 2000 which is heavily exposed to the sector. Domestic banks are considered more rate sensitive than their larger peers, contributing to small-caps underperformance so far this year.