Rising Interest Rates Boost Financial ETFs (XLF, IAT, JPM, BAC)
The notion that interest rates will be higher can be agreed upon by nearly everyone on Wall Street.
What has been up in the air is when rates will begin to increase and by how much. On Wednesday, the Fed and head Janet Yellen made hawkish comments that have shone some clarity on to when rates will begin to rise.
After the FOMC announcement the yield on the 10-year Treasury bond leaped from 2.70 percent to 2.77 percent. This is the highest yield in a week, but remains below the 3.03 percent the bond was yielding to begin the year.
As the tapering continues and the Fed believes the economy can stand on its own it will move closer to increasing the Fed Funds rate from the historical low it has been sitting at for five years.
Another debate is how rising interest rates will affect specific sectors in the market. The early stages of rising interest rates can be viewed as a positive for the financial stocks, especially the regional banks.
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The reason rising interest rates could be beneficial for banks has to do with lending money. Even though banks are able to borrow money at historically low rates, the net interest margin has been declining. In simple terms, the amount the banks can charge to borrow money is also very low, squeezing the margins made by lending out money.
As interest rates increase, so do the interest rates banks can lend money to borrowers and therefore the net margin increases and so does the amount the profit for the banks.
This is why the financial stocks and ETFs are rallying today, with many big names breaking out.
JP Morgan Chase (NYSE: JPM) is rallying over 2 percent today to the best level in 14 years as volume has picked up since the Fed announcement. Joining JPM in the breakout club is Wells Fargo & Company (NYSE: WFC), which is trading at a new all-time high and Bank of America (NYSE: BAC) is at a four-year high.
The SPDR Financial ETF (NYSE: XLF) is trading just below its best level since 2008, however it has a long way to go to get back to its pre-financial crisis level. The top holdings include WFC, JPM, BAC, along with Berkshire Hathaway (NYSE: BRKB).
The iShares Dow Jones U.S. Regional Banks Index ETF (NYSE: IAT) is also at its best level since 2008 with its top two holding USB and PNC breaking out. The top two stocks make up 31 percent of the portfolio.
The debate over whether rising interest rates is a positive for the financials will continue to rage on, but the only thing that matters is how the stocks perform and so far it appears it will be a bullish event.
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