Flattening Yield Curve Puts Pressure On Banks

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A lot of Wall Street number-crunchers are going to be chained to their desks tomorrow when JPMorgan Chase, Citigroup and Wells Fargo all report second-quarter earnings more or less simultaneously.

Truth be told, all is not well in bank-land, where the KBW Bank Index has fallen 1.5% this year while the S&P 500 is up 3.5%. That’s a notable reversal in fortunes for one of the stock market’s best performing groups for better than a year after the last presidential election. Some of the decline reflects worry that the Trump administration’s protectionist trade policies will harm the economy, but that’s only part of the story.

The bigger challenge for banks is the flattening yield curve, a term used to describe what happens when interest rates for short-term and long-term borrowing converge. The yield on the 2-year government bond has doubled in the past year and now stands at 2.59%, just 26 basis points below the 10-year bond. The increase reflects how market rates for money are keeping step with the Federal Reserve, which has been raising rates and signaled it will continue to do so.

The tightening spread is bad news for banks, which make most of their money by borrowing from the government at a low rate and charging customers a higher one. When the difference between short-term and long-term rates is small, there’s less money to be made from lending and banks likely will do less of it, which could choke off economic growth.

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The flattening yield curve helps explain why analysts at Keefe, Bruyette & Woods expect JPMorgan, the city’s largest small-business lender, to report lower commercial-banking revenue for the second quarter. The flattening curve also poses a big challenge to smaller lenders such as New York Community and Sterling Bancorp, which don’t have trading desks or money-management divisions to help offset a reduction in net interest margin.

With the core business of lending seemingly taking a turn for the worse, banks are relying on lower tax bills—due to the Trump tax cuts—to lift earnings. JPMorgan’s second-quarter tax bill is expected to be $1.4 billion lower than a year ago, according to KBW. As it happens, the bank’s profits are expected to rise by $1.5 billion.


So when does the 2s10s invert?

weak action in XLF

XLF versus Copper


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