Yields are skyrocketing. What does this mean for trading bank stocks?

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The market saw the yield on the benchmark 10-year Treasury note rise from 2.36% on April 1 to 2.71% on April 8. Traders in the fixed income world focused on inflation concerns, as well as the Federal Reserve’s plans for monetary tightening. Regarding its key overnight rate, the Fed raised rates by 25 basis points* at its March FOMC meeting. Meanwhile, the central bank has begun to outline plans to reduce the size of its balance sheet. Comments from Fed Governor Lael Brainard sent 10-year yields higher after warning that the pace of balance sheet shrinkage could be rapid.

So what does all this mean for stocks of banks and other financial companies?

Typically, bank stocks enjoy higher long-term rates. Higher rates widen the gap between what banks pay on deposits and what they can earn by lending money (their so-called net interest margin).

There are a number of potential catalysts for even higher 10-year yields in the weeks ahead. Here are two to watch out for:

  • On April 14, Import Price Index data will be released by the Bureau of Labor Statistics. A warmer-than-expected reading could push bond yields higher again.
  • May 4and, a two-day FOMC meeting ends. There is growing speculation in the market (which is reflected in market prices) that the Fed might hike 50 basis points. A 50 bps rise, coupled with a hawkish statement from the FOMC, could be enough to push the 10-year yield higher.

After massively underperforming the S&P 500* for most of 2020, banking stocks performed very well in the first quarter of 2021 and then traded more or less in line with the broader market ever since. That said, on a relative basis, they’re still below pre-COVID levels, and the past month or so has been tough. Could this relative weakness be reversed?

As the following chart shows, the Russell 1000 Financials 40 Act 15/22.5 Daily Capped Index* and the 10-year yield moved in the same direction from March 11 to March 28. The rise in yields went hand in hand with the rise in bank stocks.

Source: Yahoo Finance. Past performance does not represent future results. You cannot invest directly in an index

Over the past week, however, general risk aversion has seen this relationship crumble. Spooked by higher rates, stocks sold off, which also sent bank stocks tumbling. Traders who think bank stocks will reaffirm their link to returns can play it by holding FAS, the Direxion Daily Financial Bull 3X Shares ETF. Bank stocks could also benefit if the current risk environment eases and pushes the market higher overall.

The other side of the trade

Higher rates are not a certainty. Traders looking to express a bearish view on yields can use FAZ (the Direxion Daily Financial Bear 3X Shares ETF) to bet that interest rates will fall and bank stocks will be dragged down with them. And even if rates remain high, bank stocks could remain vulnerable if the overall market remains bearish.

*Definitions:

– A basis point is equal to 1/100th of 1%.

– The S&P500is a stock market index that tracks the performance of 500 major publicly traded companies in the United States.

– The Russell 1000 Financials 40 Act 15/22.5 Daily Capped Index measures the performance of large cap US companies that are assigned to the financial sector by the ICB sector classification framework.

Leveraged and inverse ETFs pursue leveraged daily investment objectives, which means they are riskier than alternatives that do not use leverage. They aim for daily targets and should not track the underlying index for periods longer than one day. They are not suitable for all investors and should only be used by knowledgeable investors who understand the risk of leverage and who actively manage their investments.

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Directionxion shares the risks – An investment in each Sub-Fund involves risks, including the possible loss of principal. Each Fund is non-diversified and involves risks associated with the concentration of the Funds’ investments in a particular industry, sector or geographic region, which may result in increased volatility. The use of derivatives such as futures and swaps is subject to market risks which may cause their price to fluctuate over time. The risks of each Fund include the effects of market capitalization and volatility risk, leverage risk, market risk, counterparty risk, rebalancing risk, intraday investment risk, other investment companies (including ETFs) and the risks specific to financial sector securities. . The performance of companies in the financial sector can be significantly affected by many factors, including, but not limited to, government regulations, economic conditions, credit rating downgrades, changes in interest rates interest rates and reduced liquidity in credit markets. Additional risks include, for Direxion Daily Financial Bull 3X Shares, Daily Index Correlation Risk, and for Direxion Daily Financial Bear 3X Shares, Daily Inverted Index Correlation Risk and transaction risks. overdraft and in cash. Please see the summary and full prospectus for a more complete description of these and other risks of each Fund.

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