Banks Surge On Inflationist Dream Scenario

 

If 2020 was a nightmare, 2021 may be a dream scenario for banks. The bullish party kicked off following last night’s election results in Georgia that appeared to hand the Democrats the Senate. The idea of a unified legislative and executive branch sent bond yields surging today as the embers of inflation get stoked. Clearly, the market is expecting a further blending of fiscal and monetary policy and financials appear to have won the inflation sweepstakes.

Banks and Inflation

You may be wondering why banks like inflation. The correlation is rooted in the yield curve. Since the Federal Reserve sets the rate at which banks can lend overnight, banks can get access to capital for virtually nothing. This is because the Fed lowered rates to zero last year.

 

The question about bank profitability lies in their ability to lend at a higher rate than they borrow. This margin is referred to as “net interest margin (NIM).” Every earnings, banks report their NIM and their net interest income (NII) and it gives you a sense of the state of lending profitability. Thus, lower borrowing costs for banks and higher rates for borrowers mean more money for banks.

Banks and the Yield Curve

U.S. Treasury yields represent the risk-free rate, and the term structure of the Treasury market is represented by the yield curve. The Fed has the greatest influence on short term Treasury yields and inflation impacts long-term Treasury yields. With the Fed setting rates at zero and inflation causing long-term bonds to sell-off, the yield curve is steepening and the NIM is looking to expand.

The chart below is of the 10-year U.S. Treasury note yield. Since the outset of the pandemic, the 10-year only traded above 1% briefly on March 18 and March 19, 2020. That was after the Fed stepped in aggressively with some of the additional bond buying programs. The yield closed above that threshold today, finishing at 1.04%.

Today’s sell-off is a major event for banks and the market. The higher yields will help the NIM for banks but may cause the valuation of companies to fall with a higher discount rate. The tightrope for the Fed is to walk a line of higher inflation expectations without blowing out long-term yields. This is where the pressure to institute yield curve control will begin to mount.

1 2
View single page >> |

Disclaimer: Neither TheoTrade or any of its officers, directors, employees, other personnel, representatives, agents or independent contractors is, in such capacities, a licensed financial adviser, ...

more
How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.