Bank stocks have surged in recent days and the KBW Nasdaq Bank index has climbed 8% in the past three weeks as the Federal Reserve began raising interest rates on March 16.
Rising rates help banks because they are able to increase their lending rates faster and by a larger amount than they increase their deposit rates. They can thus earn more interest than they pay on deposits.
The Fed’s median forecast for a 2.8% federal funds rate target at the end of 2023 is optimistic for banks, Bank of America analysts, led by Ebrahim Poonawala, wrote in a commentary.
“The fact that rate hikes are likely to be anticipated implies a rise in our, and likely consensus, earnings estimates for 2022-23,” they said.
The surge in two-year Treasury yields in particular “is expected to have a significant impact as banks deploy excess liquidity and cash flows from bond portfolios into higher-yielding investment securities and loans,” Bank of America analysts said.
“Among our long-listed stocks, JPMorgan Chase (JPM) – Get the JPMorgan Chase & Co. report.M&T Bank (MTB) – Get the M&T Bank Company Report and Signature Bank (SBNY) – Get the Signature Bank Report are particularly well positioned in terms of excess cash.
Certainly, “the flattening of the yield curve could temper the enthusiasm of investors and weigh on the valuation multiples” of banking stocks, analysts say.
A yield curve flattens when short-term Treasury yields rise more than long-term Treasury yields.
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“We note that this gap has little to no impact on fundamentals, but for better or worse, it is seen by many investors as a leading indicator of economic growth,” the analysts said.
Many investors view an inverted yield curve, which means short-term rates are higher than long-term rates, as a sign that a recession is approaching.
The war in Ukraine could hurt banking stocks, analysts say. The fighting could spur inflation by pushing up commodity prices and further disrupting supply chains.
It is the “key risk” to bank earnings, with “ramifications for loan growth and credit quality, especially if the U.S. economy falters,” the analysts said.
Admittedly, “a moderately inflationary environment (underlying consumer price index of around 2 to 4%) combined with [2% to 3%] of real GDP growth would be a constructive backdrop for bank stocks,” the analysts said.
The core CPI, which excludes volatile food and energy prices, rose 6.4% in the 12 months to February. GDP jumped 7% annualized in the fourth quarter.
“Our recent conversations with bank management teams suggest relatively healthy client activity to start the year,” the analysts said.
“Rate-sensitive, domestically-focused banks are likely best positioned to outperform given investors’ cautiousness about globally interconnected institutions.”
Analysts cite Wells Fargo listed as buy (WFC) – Get the Wells Fargo & Company reportM&T, Signature, Citizens Financial Group (CFG) – Get the report from Citizens Financial Group, Inc.East West Bancorp (EWBC) – Get the report from East West Bancorp, Inc.Synovus Financial (SNV) – Get the report from Synovus Financial Corp. and SVB Financial (SIVB) – Get the SVB financial group report.