The Fed has clearly pivoted. It indicated at its December FOMC meeting that, for all intents and purposes, it was done hiking and the “dot plot” is projecting three quarter-point rate cuts in 2024 against a soft landing backdrop. Fed Chair Jerome Powell was given ample opportunity to push back against the dovish narrative. Instead, he embraced it. He shrugged off concerns about easing financial conditions. He didn’t express concern about above trend growth in the economy. When asked about the “last mile” problem of reducing inflation to the Fed’s 2% target, he said, “We kind of assume it will get harder from here, but so far it hasn’t.”
The Fed pivot set off a bull steepener in the bond market, where yields fell (and bond prices rose) while the yield curve steepened. The historical evidence shows that the relative performance of bank stocks is correlated to the shape of the yield curve. There was some interruption of this relationship in 2016–2018 when the shares of banks surged when Trump was elected on the expectations of bank tax cuts, and another rally when tax cuts were passed in 2017. Otherwise, the relative performance of banks has been sensitive to the yield curve as they tend to borrow short and lend long. As a consequence, a steepening yield curve is bullish for lending margins.
The Fed pivot is the catalyst for my high conviction call to buy U.S. financials for potential outperformance.
The large banks have been slow to raise deposit rates. The benefit of lower rates on the short end will be less. The reduction of longer term rates would impact the net interest margin.
Regional banks would see a balance sheet improvement, and improving net interest income.
Am I right in thinking that regional banks would do better than large banks?
Book of business of regional banks is highly dependent on local Real estate, than the larger money center banks. As short duration interest rates come down, pretty much the entire banking sector should have a tail wind, regional banks would appear to be more leveraged to this process. Agree.
The other trade here is to sell long duration bonds and buy short duration, as FFR comes down.
Thanks! Large banks are likely to be affected by Basel III Rules. I will do a mix of KRE and a broader financial Etf.
Please take a look at IAT (instead of KBE/KRE). Thanks.
Thanks!! Will definitely do.
What would be the best ETF to express this trade? XLF, VFH, … something else?