None of the Federal Reserve officials hinting at an interest rate rise this summer would ever be as definitive as to say, “and you can take that to the bank”. But investors have. Thanks to the Fed jawboning, US bank stocks have hit their highest levels so far this year.
Since the start of May, financials have outperformed every sector except IT. The largest banking sector exchange traded fund, whose assets had previously drained away to a three-year low, also perked up suddenly; only two other ETFs have attracted more money in the past week. Expectations of future rate increases continue to be the major driver of bank shares. Higher rates mean they will be able to expand the margin between where they borrow and where they lend money out to customers, finally helping them counter the relentless squeeze on profits from regulatory actions since the crisis.
Such has been the gloom around the sector, many large banks had been trading below their estimated book value, suggesting they might as well shut up shop. This week, however, JPMorgan Chase shares have moved back into positive territory for the first time since January’s recession scare. The biggest boost to bank stocks in recent days has come from the realisation that a June rate rise is still on the cards. That in turn has led more people to bet that the Fed might even match its official forecast of two rate hikes before the end of the year. The market is pricing in a 25 per cent probability of that happening, compared to less than 10 per cent just a fortnight ago.
The rising oil price has been another tailwind for the banking sector, just as declining oil prices contributed to the sell-off earlier in the year. Investors were worried that balance sheets might be stuffed with loans to lossmaking energy companies. But while a $50 per barrel oil price might assuage some of those concerns, there is always something to worry about. The rating agency S&P warned that rising commercial real estate lending could increase risk at many regional banks.
Undervalued financial stocks have finally caught a break, but this is not a sector with much excitement around it yet. It is not in danger of overheating — and you can take that to the bank.
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