Bank stocks have jumped 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 March 16.
Rising rates help banks as they are able to lift their loan rates more quickly and by a greater amount than they lift their deposit rates. They thus can earn more in interest than they pay out on deposits.
The Fed’s median forecast for a federal funds rate target of 2.8% at the end of 2023 is bullish for banks, Bank of America analysts, led by Ebrahim Poonawala, wrote in a commentary.
“The fact that the rate hikes are likely to be front-end-loaded implies upside to our, and likely to consensus, 2022-2023” earnings estimates, they said.
The surge in two-year Treasury yields in particular “should be quite impactful, as banks deploy excess cash and cash flows from bond books into higher yielding investment securities and loans,” the Bank of America analysts said.
“Among our buy-rated stocks, JPMorgan Chase (JPM) – Get JPMorgan Chase & Co. Report, M&T Bank (MTB) – Get M&T Bank Corporation Report and Signature Bank (SBNY) – Get Signature Bank Report are particularly well positioned in terms of excess cash.”
To be sure, “the flattening in the yield curve could temper investor enthusiasm and weigh on valuation multiples” for bank stocks, the analysts said.
A flattening yield curve occurs when short-term Treasury yields rise more than long-term Treasury yields.
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“We note, that this spread has little-to-no impact on fundamentals, but for better or worse it is regarded by many investors as a leading indicator for 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 coming.
The war in Ukraine could hurt bank stocks, the analysts said. The fighting could boost inflation by pushing commodity prices higher and further disrupting supply chains.
This is the “key risk” for bank earnings, with “ramifications for loan growth and credit quality, especially if the U.S. economy falters,” the analysts said.
To be sure, “a modestly inflationary environment (core consumer price index in the 2-4% range) combined with [2% to 3%] in real GDP growth would be a constructive backdrop for bank stocks,” the analysts said.
The core CPI index, which excludes volatile food and energy prices, soared 6.4% in the 12 months through February. GDP surged an annualized 7% in the fourth quarter.
“Our recent conversations with bank management teams suggests relatively healthy customer activity to start the year,” the analysts said.
“Rate-sensitive, domestically focused banks are likely best positioned to outperform given investor caution on globally interconnected institutions.”
The analysts cite buy-rated Wells Fargo (WFC) – Get Wells Fargo & Company Report, M&T, Signature, Citizens Financial Group (CFG) – Get Citizens Financial Group, Inc. Report, East West Bancorp (EWBC) – Get East West Bancorp, Inc. Report, Synovus Financial (SNV) – Get Synovus Financial Corp. Report and SVB Financial (SIVB) – Get SVB Financial Group Report.