April 25, 2018: Market Minute: Bond yields and banks

Interest rates are set by the FOMC and reflect a number of factors.  

They are a tool to control inflation and maintain healthy economic growth. 

The FOMC rises or lowers the fed fund rate by means of through its monetary policy. When the Fed wants rates higher, it sells its securities to banks and consequently removes funds from their balance sheet. This gives banks fewer reserves which allow them to raise rates. To lower the rate, the Fed purchases securities from its member banks and deposit that credit onto the banks' balance sheet.

A trend of lower interest rates is good news for the stock market as it sends a message that the Fed is a accommodating and wishes for more economic growth.  An increase in rates says the opposite that the Fed needs to slow growth and contain inflation.

Most industries view higher rates and loan costs as a negative, except the banks.

When rates starts to rise, it gives the banks more room between the rate that they borrow from and the rate that they offer to their clients.

Short-term U.S. Treasury bond yields closely reflect the rise or fall of interest rates.   They also follow the movement of the Bank index.  This is largely due to a increase or decrease in profits that short-term rates have on the profitability of most banks.

Bottom line: U.S. 5-year Treasury bonds yields move with the U.S. Bank index.  Because of this close relationship, investors in the banking sector can gauge the trend of the banks by the yields of 5-year bonds.  These key short-term yields tend to lead the banks and can provide a valuable gauge to this sector.