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Here We Go Again: Some Traders Are Betting On A Regional Bank ETF

September 15, 2016 12:05 pm
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There are a few certainties in life. Death. Taxes. The sun rising in the east and setting in the west. All those things, and traders renewing their affinity for regional bank stocks and exchange-traded funds whenever there is a mere inkling that the Federal Reserve could be moving closer to raising interest rates.

That is the plight of the SPDR KBW Regional Banking (ETF) (NYSE: KRE), the largest regional bank ETF, and rival funds. However, that burden may be a gift at the moment. According to CME Group data, Fed funds futures are currently pricing an 85 percent chance that the Fed will raise rates by 25 to 50 basis points at its September 21 meeting.

That is most likely the reason why KRE has been seeing inflows in recent days.

KRE’s Recent Performance

KRE “has seen substantial inflows this week to the tune of about $250 million, and we note that the fund’s asset base is just north of $2 billion at the moment,” said Street One Financial Paul Weisbruch in a note out Wednesday.

Related Link: Bank Of England Maintains Current Interest Rates But Hints Of Another Rate Cut This Year

Inflows are only part of the story. KRE's price action confirms its sensitivity to rising rates speculation. Although KRE is still modestly lower on a year-to-date basis, the ETF is higher by 6.1 percent over the past 90 days.

The Role Of Interest Rates

Regional bank funds like KRE are seen as prime beneficiaries of higher interest rates. Simply put, net interest margins at regional banks have been suppressed by the Fed's zero interest rate policy and reversing that policy is seen as an important catalyst in boosting profits for the banks in ETFs such as KRE.

Higher interest rates are seen as boons for regional banks' net interest margins, a key measure of profitability for these banks. KRE's positive correlation to rising Treasury yields is nearly double that of the Financial Select Sector SPDR Fund (NYSE: XLF) and more than quadruple of that S&P 500.

Translation: KRE is more levered to rising rates than traditional financial services ETFs so those that get long this ETF in the coming weeks need some help from the Fed.

“Year-to-date, KRE has actually still experienced net outflows of about $475 million out, but that said, this number has been abated a bit thanks to this week’s creation fervor. KRE tracks the S&P Regional Banks Select Industry Index, which is made up mostly of Mid and Small-Cap banks — not the JPM, WFC, and C’s of the world. In fact, 50 percent of the portfolio resides in the Mid-Cap space. There is also substantial exposure to Small-Caps of 31 percent, and even a 3 percent slice dedicated to Microcap regional banks,” added Weisbruch.

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Disclosure: Todd Shriber owns shares of XLF.

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