Chang­ing dy­namic in bond mar­ket amid Fed rate moves start­ing to give pause to some stock ral­lies

New Straits Times - - Business -

BANK shares have been the run­away win­ners of the post-elec­tion United States stock mar­ket boom as in­vestors wa­gered that higher in­ter­est rates, lighter reg­u­la­tion, lower taxes and faster eco­nomic growth would boost prof­its for lenders.

Up 32 per cent since the elec­tion of Don­ald Trump, the Stan­dard & Poor’s 500 bank in­dex has out­paced the wider mar­ket’s gain by roughly 3-to-1.

Now, how­ever, a chang­ing dy­namic in the bond mar­ket as the US Fed­eral Re­serve gears up to raise in­ter­est rates at a faster pace than many had pre­vi­ously ex­pected is be­gin­ning to give pause to some early bank stock bulls.

With an­other strong US jobs re­port in the books, the Fed is widely ex­pected to raise overnight in­ter­est rates on Wed­nes­day, and is now seen de­liv­er­ing three rate hikes this year.

Ris­ing rates can boost bank prof­its, but bank prof­itabil­ity also hinges on the dif­fer­ence be­tween short­term rates, like those set by the Fed and which tend to mark the cost for banks to ac­quire their funds, and long-term rates, which serve as bench­marks for what banks charge their cus­tomers for loans.

When that dif­fer­ence, or spread, is large, bank prof­its can rise rapidly. When it nar­rows, or flat­tens, profit growth can suf­fer.

At is­sue now is what some in­vestors see as a grow­ing risk of a flat­ten­ing yield curve un­der a more ag­gres­sive rate-hike path by the Fed.

For­wards pric­ing for two and 10-year Trea­sury yields sug­gests the spread be­tween them would nar­row to about 93 ba­sis points by year-end from the cur­rent 122 points.

That is why Jef­frey Gund­lach, chief ex­ec­u­tive of­fi­cer at Dou­bleLine Cap­i­tal and an early buyer of the Trump rally, said he has sold his fi­nan­cial stocks.

In the month after the Novem­ber 8 US Pres­i­den­tial elec­tion the S&P 500 bank in­dex rose 24 per cent. Since then the stocks have risen 5.7 per cent as many in­vestors awaited con­crete signs of reg­u­la­tory and tax re­form.

To be sure, the bank rally has been grounded on more than just rate hike ex­pec­ta­tions and yield curve fore­casts.

In­vestor in­ter­est has also been stoked by as­sump­tions about Trump’s agenda in Wash­ing­ton.

In­vestors have been bet­ting that Trump’s prom­ises of tax cuts would boost con­sumer spend­ing and com­pany prof­its, which would drive loan de­mand.

Mean­while, his prom­ise to slash reg­u­la­tions could also cut com­pli­ance costs and al­low banks to ex­pand their loan port­fo­lios more rapidly.

That is among the rea­sons why David Le­bovitz, global mar­ket strate­gist at J.P. Mor­gan As­set Man­age­ment, still ex­pects more gains for fi­nan­cial stocks.

Even if reg­u­la­tory and tax re­form looks like it would take a long time, in­vestors would likely be pa­tient as long as Trump’s ad­min­is­tra­tion pro­vides more specifics on its plans in­clud­ing timeta­bles, said Le­bovitz.

But he cau­tioned that “dis­ap­point­ment on the pol­icy front is the big­gest risk” to stocks right now as in­vestors have priced in pol­icy changes al­ready.

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