With the Federal Reserve’s rate cut earlier this week, I am recommending a bearish trade on the SPDR S&P Regional Banking ETF (NYSEARCA:KRE).
My indicators are giving strong sell signals this week because of the extreme volatility in the market.
The Federal Reserve cut the target federal funds rate by 50 basis points, or 0.50%, this week to a range of 1.00%-1.25%. The cut was intended to stimulate the economy and alleviate some of the pressure created by the virus outbreak.
Many investors had been hoping for a rate cut, and they pushed the market higher on Monday because it was rumored the Fed might intervene. When the cut was announced on Tuesday, investors reacted poorly and sent the markets lower.
The rate cut, while theoretically giving them what they wanted, also confirmed the severity of the COVID-19 outbreak.
What Has the Rate Cut Done?
The COVID-19 outbreak’s effect on the market isn’t something the Fed is capable of dealing with alone. In his comments after the cut, Fed Chair Jerome Powell said, “We do recognize that a rate cut will not reduce the rate of infection.”
Investors won’t be satisfied until the virus itself is dealt with, and containing some of its economic effects with a rate cut isn’t enough.
In fact, the Fed’s cuts limit the tools available to it in the event of another, more fundamental issue in the economy, and regardless of any central bank’s actions, we will see the market bounce back and forth as positive and negative COVID-19 headlines come in.
The Fed’s rate cuts did have one concrete effect on the market. On the monthly chart of the CBOE 10-year Treasury Note Yield Index (TNX), you can see that the 10-year Treasury yield is lower than at any other point in history.
Monthly Chart of the CBOE 10-year Treasury Note Yield Index (TNX) — Chart Source: TradingView
The yield on 10-year Treasury notes drives longer-term interest rates, and lower short-term and long-term interest rates will reduce banks’ ability to profit in the short term. Larger banks have ways around lower net interest margins, but smaller banks will be more affected. A bearish trade on KRE is an excellent way to take advantage.
KRE’s Support Won’t Hold
If you look at the chart below, you can see that KRE has dropped well below support at around $48 per share, and its next support level is at $44.
Daily Chart of SPDR S&P Regional Banking ETF (KRE) — Chart Source: TradingView
The rate cut will definitely make things harder for smaller banks, and COVID-19 is still a major headline risk, driving the market up and down every day.
I don’t think KRE’s support at $44 will hold up under such poor fundamental conditions, so I am recommending a bearish put option with a strike below support.
Buy to open the SPDR S&P Regional Banking ETF (KRE) June 19th $42 Puts (KRE200619P00042000) at $1.80 or lower.
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