Today It’s The Banks’ Turn, But That Harbors A Risk

Here’s the rub. Consider this graph:

2 Year Graph of Rolling 10 Year Bond Futures

(Click on image to enlarge)

2 Year Graph of Rolling 10 Year Bond Futures

Source: Interactive Brokers TWS

This graph displays the price of 10 year Treasury bond futures. Remember that bond prices move inversely to yields. We can see that the massive rise in T-bond prices seems to have ended, and maybe rolling over. Today’s investors in financial stocks are banking on the idea that yields could continue to rise. We can see that there is plenty of room for that. A return even to pre-Covid levels would push long-term rates by 50 basis points or more. That would be good for a bank’s income statement.

Yet a rise in rates could be perilous for the market as a whole. A broad range of investors have used low-interest rates to justify historically high stock valuations. If those valuations are threatened by rising rates, it could pose a real headwind for a market that is top-heavy with high P/E names. 

We find ourselves with a fascinating conundrum. Markets are anticipating a stronger economy as we emerge from the pandemic. That anticipation is reflected in high stock prices and rising bond yields. The problem becomes, if the economy is strong enough to boost bond yields sharply, that could impede the stocks that base their valuation on low yields. It is rational for investors to hedge that risk by rotating into stocks that could indeed benefit from rising rates. Banks fit that bill. But this healthy rotation could indeed be the harbinger of something more worrisome.

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Disclosure: FUTURES TRADING

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