Interest rates have been the talk on Wall Street for some time now, and as they’ve started to move higher recently there is one group in particular that has reaped the benefits. With the yield on the 10-year Treasury bond surging from 2.1% to 2.4% in a matter of a month, the financial group has been off to the races.
Higher interest rates are beneficial to the financials because increased lending margins equate to higher profits, and investors are jumping on board now to take advantage of the long-term potential. As a result, the Financial Select Sector SPDR ETF (XLF) has rallied more than 7% since the start of June.
This week investors will get their first look at the group’s second-quarter results. Financials as a whole are expected to have grown earnings 6% year-over-year, but when you exclude the insurance industry those estimates fall to just 2.8% growth. With the bar set relatively low, there is a lot of room for big upside surprises.
However, we need to keep an eye on the 10-year Treasury. If the yield starts to head south again, it could put a lid on XLF’s rally. We saw this happen on Wednesday following comments from Federal Reserve Chair Janet Yellen: the yield dipped – and XLF did briefly as well – as the market expects the central bank to raise rates at a slow pace.
Technically, XLF has been following the trajectory of the 10-year Treasury and is now forming a double top at the nine-year high of $25.25. The second-quarter earnings season could be enough to take it over the top, but if the yield turns lower even a strong cycle may not cut it.
For now, I’m keeping an eye on the 10-year. As long as it remains solid and earnings come in strong, I consider XLF a good buy.