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A Widening of the Yield Curve should Help Banks

David Becker
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A Widening of the Yield Curve should Help Banks

Despite the better than expected gains seen in many of the large banks including Citigroup (NYSE:C) and JP Morgan (NYSE:JPM) , a narrowing of the interest rate curve has created headwinds for banks. Banks generally borrow short, lend long, which creates income from financial institutions as they borrow from the Federal Reserve, and lend to consumers. If the yield curve begins to widen, banks could see continued positive gains.

The Yield Curve (the 10-year interest rate minus the 2-year interest rate) had been climb from May to December but then proceeded to fall from January to July. This is the difference between the 10-year Treasury Yield and the 2-year Treasury Yield is the yield curve. This spread, has narrowed significantly over the last six months. There seems to be a high correlation between banking stock prices and the yield curve. This is because banks earn more money when the spread widens. An upturn in the Yield Curve would, therefore, be positive for banks.

What will likely help the banks even further would be a strengthening of the U.S. economy and higher longer term yields. Since the short end of the yield curve is anchored as the Fed is unlikely to raise rates anytime soon, the yield curve will only steepen, if the long end of the yield curve begins to back up. This would require the 10-year yield to begin to climb, which would only occur if inflation and growth began to pick up.

Recent banking results were strong with Citigroup posting solid earnings, and JP Morgan following on Tuesday will well better than expected numbers. JP Morgan earnings 1.46 per share compared to the 1.29 per share expected by economists.

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