The 10-year Treasury yields have been on a steep rise in recent months. It climbed to the highest levels in nearly a year after registering a biggest weekly rise since June. On the other hand, short-term yields are on a steady rise given the persistent surge in COVID-19 cases, indicating that the yield curve is steepening.

Notably, the 10-year yields jumped to 1.165% while 2-year yields edged up to 0.149% on Jan 12. The spread between these two yields widened to 1.02 percentage points, marking the steepest yield curve since May 2017.

Yield Curve Steepens

The steepening of the yield curve came on the back of inflationary expectations. The 10-year U.S. breakeven inflation rate, a proxy for annual inflation expectations, climbed above 2.10% this week for the first time since 2018.

The massive money flowing into the economy coupled with hopes of a bigger fiscal stimulus and more Treasury supply under a Democratic-led U.S. Congress is expected to lift inflation and in turn driving the long-term yields higher. Additionally, the wider reach of COVID-19 vaccinations has spurred the expectation for a swift economic recovery, pushing the long-term yields higher. An improving economy will buoy demand for loans and all types of banking services.

On the other hand, the Fed has pledged to keep short-term interest rates near zero until “substantial further progress” has been made toward reaching maximum employment and healthy inflation. According to Mizuho International Plc’s Peter Chatwell “a resurgence in global growth in 2021, along with the Federal Reserve’s increased tolerance for inflation, should fuel price pressures.” The inflation rate could reach or surpass the Federal Reserve’s 2% target in some months.

Banks to Win

As banks seek to borrow money at short-term rates and lend at long-term rates, a steepening yield curve will earn more on lending and pay less on deposits, thereby leading to a wider spread. This will expand net margins and increase banks profits.

Given this, investors seeking to take advantage of the steep yield curve should bet on bank ETFs. These funds have gained in double digits over the past month and have a Zacks ETF Rank #3 (Hold).
  
SPDR S&P Regional Banking ETF (KRE - Free Report)

This fund, having AUM of $2.4 billion and an average trading volume of around 8.5 million shares, offers exposure to regional banks. It follows the S&P Regional Banks Select Industry Index, charging investors 35 bps a year in fees. KRE holds 129 securities in its basket.

Invesco KBW Regional Banking ETF (KBWR - Free Report)

This fund follows the KBW Nasdaq Regional Banking Index, holding 50 stocks in its basket. It is a relatively less-popular and less-liquid option in the space, with AUM of $45 million and an average daily volume of 10,000 shares. It charges 35 bps in fees per year from investors.

First Trust NASDAQ ABA Community Bank Index Fund (QABA - Free Report)

This ETF offers exposure to banks and thrifts, and tracks the NASDAQ OMX ABA Community Bank Index, holding 163 stocks in its basket. It has accumulated $98.3 million in its asset base and charges 60 bps in annual fees. It trades in volume of 27,000 shares a day, on average.

iShares U.S. Regional Banks ETF (IAT - Free Report)

This ETF offers exposure to 54 small and mid-cap regional bank stocks by tracking the Dow Jones U.S. Select Regional Banks Index. The fund has amassed $320.7 million in its asset base and sees a good volume of 147,000 shares a day. It charges 42 bps in annual fees.

SPDR S&P Bank ETF (KBE - Free Report)

This fund offers equal-weight exposure to 90 banking stocks by tracking the S&P Banks Select Industry Index. Regional banks dominate the portfolio with 70.6% share while thrifts & mortgage finance, diversified banks, other diversified financial services and asset management & custody banks take the remainder. It has amassed $2.9 billion in its asset base while trading in heavy volume of 3.2 million shares a day, on average. The product charges 35 bps in annual fees.

First Trust Nasdaq Bank ETF (FTXO - Free Report)

This fund follows the Nasdaq US Smart Banks Index, which measures the performance of U.S. companies within the banking industry. It holds 29 securities in its basket and charges 60 bps in annual fees. The ETF has AUM of $127.7 million and trades in an average daily volume of 83,000 shares.