Headwinds Facing Banks

One measure of the health of the U.S. economy just logged its worst losing streak ever. The most popular banking sector exchange-traded fund, the Financial Select Sector SPDR ETF (symbol XLF) , marked its 13^th consecutive drop—its longest losing streak ever and an indication of the headwinds facing lenders despite a strengthening U.S. economy and the repeal of unfavorable regulations.

The ETF holds shares of some of the biggest banks, household names like J.P. Morgan Chase, Citigroup, and Bank of America. What’s the problem? Many believe that it can be traced to the flattening yield curve. Since banks “borrow short and lend long”, they rely upon a significant difference between short-term interest rates and long-term interest rates for profitability.

The flattening of the yield curve is the enemy of bank profitability – and the enemy is advancing. The chart below, from the Fed, shows that the 10-year minus 2-year difference is down to just 0.31% - the lowest spread since 2007.

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