Banks are not yet sweating an inversion of the yield curve
Banks are not yet sweating an inversion of the yield curve

Two-year yields briefly climbed a fraction of a basis point above 10-year yields on Tuesday, inverting that part of the curve for the first time since August 2019. This has often signaled a slowdown economic looming in the past, though some investors and economists say the spread between three-month and 10-year yields is a better guide — and it’s far from reversing.

Obviously, if the United States plunges into recession, the banks will take a hit. But will he? So far, economists are only placing a 20% chance on that outcome next year. Indeed, if a recession does materialize, there’s reason to believe it won’t happen until next year or 2024, as the fallout from the Federal Reserve’s fight against the worst inflation in 40 years puts time to be transmitted to the real economy. Yield curves have a habit of calling recessions early on, as they did in the late 1980s and 1990s.

Economic data and corporate earnings have mostly held up, but the market still has little evidence on how consumers fared over the past month as gasoline prices soared. and that the cost of many types of borrowing has skyrocketed. Over the past week, housing data has contributed to slight downward shifts in growth expectations. Meanwhile, the Chicago Fed’s Advanced Retail Trade Summary – based on high-frequency indicators including credit card activity, foot traffic and sentiment – predicted that retail sales and catering excluding automobiles would fall by 3.2% in March compared to February, a fall of 4.4% on an inflation-adjusted basis. Most of the time, however, the fear is that increasingly aggressive monetary policy tightening will turn out to be the 18-wheeler that breaks the camel’s back.

Bank profits are closely tied to interest rates and economic growth: lending helps drive the economy forward, and higher rates make lending more profitable. The yield curve is still widely regarded as an indicator of bank profitability based on the idea that banks use cheaper short-term deposits to fund long-term loans. They are hoarding it and bank stocks should rally when the curve is steep and cut lending when the recession looms.

Indeed, the Fed’s survey of bank loan officers shows that they tightened lending standards after the yield curve inverted in the late 1990s, before the 2008 financial crisis and even in 2019. But right now, banks are lending freely and their stock prices are recovering. even as the two- to ten-year yield curve collapsed. In fact, US bank stocks have tracked 10-year yields at least as much as they have tracked the spread between 2- and 10-year yields for most of the past 20 years.

This is partly because the simple banking model described above is outdated, especially in the United States. Banks create loans but quickly sell large numbers on capital markets: mortgages are converted into mortgage bonds; a lot of credit card and auto finance debt is securitized; and large corporations mainly borrow longer-term debt directly from bond markets.

Bank lending as a share of total credit in the US economy is less than 30%, according to Citigroup data. At the end of the 1970s, bank loans still represented more than 50% of total credit. With the rapid growth of private credit funds lending to small businesses and fintech companies competing with credit cards, this share could continue to decline.

Rates are always important for banks: although they earn fees on the origination and sale of loans, they also earn interest on shorter-term debt like revolving credit, bridge loans and other financing. working capital. They also buy a lot of treasury bills and other bonds and get the yield from them. When rates rise, the best performing banks are those that can most quickly reinvest deposits in higher-yielding debt securities and refinance or reprice shorter-term loans.

Banking investors view 10-year yields as a signal of growth. The curve is distorted only because two-year yields are rising faster as the market adjusts to the Fed’s view that growth is strong and interest rates will need to rise sharply to fight inflation galloping.

Investors have seen this story before in previous rate hike cycles. A rapidly flattening yield curve, alongside rising 10-year yields and rising bank stocks, was also evident from 2004 to 2006 and 2016 to 2018. At some point, rising rates will hurt to the economy and the banks, but not yet.

More other writers at Bloomberg Opinion:

• Not all yield curve inversions are fatal: John Authers

• The Fed made a US recession inevitable: Bill Dudley

• The yield curve is often good for the wrong reasons: Robert Burgess

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. He previously worked for the Wall Street Journal and the Financial Times.

Jonathan Levin has worked as a Bloomberg reporter in Latin America and the United States, covering finance, markets, and mergers and acquisitions. Most recently, he served as the company’s Miami office manager. He holds the CFA charter.


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