U.S. Recession Worries Drive a Split Between Yields and Bank Stocks

(Bloomberg) -- Banks stocks fell for sixth day as growing worries about a U.S. recession drove a wedge even further between their performance and the surge seen in Treasury yields in recent weeks.

The KBW Bank Index dropped 1.4% Wednesday in its longest losing streak since January 2021, even as the 10-year yield jumped above 2.6% for the first time in three years. Big bank stocks, including Citigroup Inc., JPMorgan Chase & Co. and Morgan Stanley all fell by at least 1.5%, while regional names such as Western Alliance Bancorp, PacWest Bancorp and United Community Banks, Inc. were all lower by 2% or more.

“The primary reason to sell bank stocks today would be the anticipation that the Federal Reserve will be too aggressive with its monetary policy in its efforts to reduce inflation which results in the U.S. economy going into a recession in 2022,” RBC Capital Markets analyst Gerard Cassidy wrote in a note.

The split between bank stocks and yields has grown in recent weeks amid concerns that aggressive tightening by the Federal Reserve will erode economic growth, curtailing loan demand and forcing banks to increase their allowances for bad loans. The KBW Bank Index has tumbled nearly 19% since hitting a record high in early January, while the 10-year Treasury yield has surged.

It's a dynamic that's shifted dramatically from earlier this year, when banks and yields were reliably moving higher, and financial shares were viewed by traders as the hallmark value trade.

Back then, the bet was that higher yields would translate to fatter bank profits and wider net interest margins. In 2021, the KBW Bank Index surged 35%, handing investors their best returns since 2013 and just short of their biggest jump since 1997.

Now the analysis seems to be changing, and analysts are factoring in the negative hit of slower economic growth. Goldman Sachs Inc. analysts lead by Richard Ramsden said last week that profitability could suffer in a stagflation scenario, but the impact would be softer than during a normal recession.

Investors will be closely watching the Federal Reserve's meeting minutes, due Wednesday afternoon. The release will help give market's a clue as to the pace of coming interest-rate hikes as well as how quickly the central bank plans to shrink its balance sheet. Traders are currently betting that the Fed will lift rates by another 225 basis points by year-end, in what would be the most aggressive tightening cycle since 1994.