Conventional wisdom tells us that a steepening Treasury yield curve should lead to higher profits for bank stocks because their net interest margins — the difference between the amount of interest banks pay for their liabilities (checking and savings deposits, etc.) and the amount of interest banks receive for their assets (personal and commercial loans, etc.) — will be wider. After all, banks typically pay shorter-term rates on their liabilities and charge longer-term rates on their assets.
However, this imagined relationship hasn’t held up very well during the past few years.
If you look at the graph of the relationship between the yield on the 10-year Treasury and the yield on the 2-year Treasury in Fig. 1, you will see that the spread between these two yields has been getting smaller and smaller (meaning the yield curve has been flattening) during the past few years.
Fig. 1 — 10-Year Treasury Yield Minus 2-Year Treasury Yield (source: FRED Economic Data)
This same relationship holds true if you go further out the yield curve and you look at the graph of the relationship between the yield on the 30-year Treasury and the yield on the 10-year Treasury in Fig. 2.
As you can see, the spread between these two longer-term yields has also been getting smaller during the past few years.
Fig. 2 — 30-Year Treasury Yield Minus 10-Year Treasury Yield (source: FRED Economic Data)
Interestingly, for the past few years, the net interest margin enjoyed by banks in the United States has been increasing (see Fig. 3).
Fig. 3 — Net Interest Margin for All U.S. Banks (source: FRED Economic Data)
This is exactly the opposite relationship we would expect to be seeing right now if the conventional wisdom — that the slope of the yield curve drives net interest margins — were true.
In fact, the Bank of England (BOE) recently released a study in which it found that the slope of the yield curve had no positive correlation with the level of net interest margin enjoyed by banks. Rather, this study found that net interest margins tended to have a closer relationship with long-term interest rates, like the yield on the 30-year Treasury.
Looking at the yield on the 30-year Treasury in Fig. 4, you can see that longer-term rates have been stabilizing and rising at the same time that net interest margin levels have been picking back up.
Fig. 4 — 30-Year Treasury Yield (source: FRED Economic Data)
Based on the currently observed relationship between longer-term yields and net interest margin, if the yield on the 30-year Treasury can break through resistance at ~3.25%, moving closer to 3.5% or 4%, it should have a positive impact on net interest margins, which could help push bank stocks higher.
However, it is important to remember that net interest margin is only one of many fundamental factors that could have an impact on bank stocks. Looking at a monthly chart of the iShares U.S. Financial Services ETF (NYSEARCA:IYG) in Fig. 5, you can see that bank and other financial stocks had no problem climbing higher from 2012 through 2015 while net interest margin levels were falling.
Fig. 5 — Monthly Chart of the iShares U.S. Financial Services ETF (IYG)
The Bottom Line on Bank Stocks
Keep your eyes on longer-term Treasury yields and net interest margin levels. If the U.S. economy remains strong, these may be two fundamental factors that can help push banks stocks up through resistance and on to new highs.
You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next SlingShot Trader trade and get 1 free month today by clicking here.