The Federal Reserve Bank is widely expected to hike interest rates tomorrow for the fourth time since December 2015. Both the 10-year yield and bank stocks like Bank Of America Corporation (NYSE:BAC) have corrected lower following the last three Fed hikes. Bank of America’s stock price is heavily influenced by yields since the bank’s loan book is comprised of a substantial amount of variable rate loans.
Although the market is on Fed watch to see if Yellen and company hike rates, the verbiage following the meeting will be more important since it may contain indications of winding down the enormous $4.5T Fed balance sheet.
The Fed Chair, Janet Yellen, is unlikely to make any bold statements about balance sheet reduction since Yellen has stated many times that the Fed will go about hiking at a gradual pace.
It may seem surprising (at least it was to me) that the 10-year yield has fallen in the days following the last three Fed hikes. As a result, bank stocks like Bank of America have corrected in lock step.
If you follow my articles on Seeking Alpha, you know that my writing centers around investment risk management. Since most stock brokers studied finance in college, they often focus more on P/E ratios and less on economics and global capital flows.
However, these large flows from big money (hedge fund or central bank money) create the overall trend in the markets influencing the value of bond yields, currency exchange rates, and ultimately equities like bank stocks. By monitoring the trends and the large flows of global capital, we can help avoid that dreaded “bad trade” or avoid getting stopped out of a good trade that eventually might have been a winner in the long run.
This analysis is not meant to sound negative on banks in fact, I believe banks should do well in both a rising growth and yield environment.
Below is the 10-year yield volatility following the last three Fed hikes.
- The most shallow correction in the 10-year yield was 11% in December 2016.
- Most of the corrections were preceded by a rally in yields. However, the Fed meeting tomorrow is different. We’re currently sitting at a 2.20% 10-year yield. As a result, it may not take much to move yields lower since the trend is bearish.
Why do yields fall after a hike in interest rates?
- Lowered expectations of U.S growth due to weak Q1 growth and waning optimism in President Trump’s business friendly agenda getting passed this year has weighed heavily on the 10-year yield.
- The 10-year yield if you recall is largely driven by inflation and growth expectations, while the two-year yield is driven by Fed action or hikes. This is why sometimes we see the two-year yield rise after the Fed hikes, while the 10-year yield falls as investor optimism surrounding growth wanes. If you need a guide on how the two-year and…