Likely too early to expect a bottom on the S&P 500. Instead, we find that long-term interest rate tend to drive bank margins. As banks seek to borrow money at short-term rates and lend at long-term rates, a steepening yield curve will earn more on lending and pay less on deposits, thereby leading to a wider … 0.039% A steeper yield curve is a bank investor’s new best friend - The Globe and Mail A steeper yield curve is a bank investor’s new best friend David Berman Investment Reporter Published … Bank profitability tends to increase after the yield curve peaks – as the curve gradually flattens. The conventional wisdom amongst financial market observers, academics, and journalists is that a steeper yield curve should be good news for bank profitability. A steeper yield curve is good for banks Banks typically borrow short term and lend longer term, which results in maturity transformation. The commonly held view is that such a steepening of the yield curve should be unequivocally good news for bank profitability because it raises banks’ net interest margins. In the example, a bank issues a loan at 3.5%, matched with bank deposits of shorter maturities offering an interest rate of 1%. Table 1: For most countries a steepening of the yield curve has historically been associated with a fall in the net interest margin, while higher long rates with an increase. from deposit accounts) and lending long term (e.g. Figure 3: UK banks’ net interest margins and the long-term interest rate have historically moved closely together but the relationship appears to have weakened post financial crisis. Some central banks, such as the Fed and the Bank of England, have started the tightening phase of monetary policy, which has been associated with a steepening of the yield curve. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees. 0.148% That creates the possibility of the yield curve steepening at the very same time banks attempt to break out of their range. Sources: World Bank, OECD, SNL and authors calculations. If the long rate rose to 5%, it would steepen the yield curve, increase the interest rate spread between lending and borrowing, and increase the NIMs. This reflects the fact that depositors are generally willing to sacrifice returns because they value the liquidity of holding their money in cash rather than in an illiquid investment. While an inverted yield curve has frequently been a harbinger of a recession, sending stock investors running for the hills, a steepening yield curve can signify the opposite, which is good … Figure 2: Simple plot of the slope of the yield curve and average bank NIMs in the United Kingdom. Using data for a panel of 10 countries over four decades, we find no systematic positive relationship between the slope of the yield curve and bank net interest margins. But new research from the Bank of England shows it isn’t the slope of the yield curve as much as long-term rates on government bonds that dictates a bank’s net interest margins, a key driver of their profitability. Figure 1 illustrates this with the aid of a stylised yield curve. No signup … Frank Eich works in the Bank’s International Surveillance Division. Understanding Curve Steepener Trades . JPMorgan Chase & Co., in its latest quarterly filing, said a steeper yield curve would boost interest income by $1.7 billion while a flatter one would lead to a $2 billion increase. Sorry, your blog cannot share posts by email. In this post, we present cross-country evidence that challenges this view. This post was written whilst Oliver Brenman was working in the Bank’s Policy and Strategy Division. The final observation. But even this latter relationship has weakened since the global financial crisis. It is worth remembering that the results are driven by the average maturity and composition of assets and liabilities of bank balance sheets. The net interest margin is the difference between the interest banks earn on the loans they make and the interest they pay to savers. As long-term rates tend to sit higher than their short-term peers, banks take advantage of the difference by lending “long” and borrowing “short” (see chart lower). That’s why stock analysts say financial shares A yield curve is simply the yield of each bond along a maturity spectrum that's plotted on a graph. The title of one of my professional bodies has very recently changed to The Society of Professional Economists. See: Bank earnings will be ‘mixed’ and ‘messy’—but there’s some good news. In its vision for key global 2021 investment themes, Goldman Sachs Group Inc. sees the U.S. yield curve steepening -- for nominal as well as real rates. the interest they pay to savers. Longer term sterling rates are determined by a number of factors, notably the expected path of sterling bank rate, and the expected path of the both the UK and global economy (and hence fund manager asset allocation between fixed interest securities and equities / other investments). This follows the success of its mRNA COVID-19 vaccine, which is one of two vaccines to be authorized so far in the U.S. CEO Moderna also said it plans to expand its respiratory syncytial virus to include older adults, and it plans to test different vaccine combinations that fight the flu, COVID-19, RSV, and human metapneumovirus. Michelle Martin and Ryan Huang discuss the steepening US yield curve, renewed interest in Singapore banks, OCBC appoints a woman CEO, CDL's shares, Apple, Google and Amazon, stimulus in the US and … It is worth noting that we wouldn’t expect this theoretical relationship, between the slope of the yield curve and NIMs, to hold perfectly in the real world. A steeper yield curve promises improved interest margins for banks, prompting strong gains for financial stocks. Such an environment is normally associated with a slowdown in the level of UK business activity, in response to both actual and anticipated monetary policy tightening. Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The yield curve is a graph showing the bond yields of various maturities ranging from 3-month T-bills to 30-year T-bonds. This will expand net margins and increase banks profits. This article challenges that conventional wisdom. The argument goes that because banks borrow short and lend long, a steeper yield curve … 2020 hindsight: what can supervisors learn from the collapse of Barings Bank 25 years on. A look at the price chart shows that banks got trapped in a range as the yield curve flattened. A steeper yield curve is one of the last remaining market disciplines enforced on governments that may start to believe they can borrow near infinite amounts without penalty. Our simple empirical results suggest that there would be a corresponding fall in bank NIMs. A very steep yield is normally associated with an eventual significant slowdown in the economy, as the monetary authorities aggressively tighten monetary policy. The bank … Click to share on Twitter (Opens in new window), Click to share on LinkedIn (Opens in new window), Click to share on Facebook (Opens in new window), Click to email this to a friend (Opens in new window), Click to share on Pocket (Opens in new window), Click to share on Reddit (Opens in new window), Click to share on Tumblr (Opens in new window), Click to share on Pinterest (Opens in new window), Is a steeper yield curve good news for banks? Copyright © 2021 MarketWatch, Inc. All rights reserved. It is worth noting that in recent decades the countries in our sample have been through large economic, structural and policy changes, such as the introduction of inflation targeting, and changes in competition, financial liberalisation and regulation. Summary. From this we conclude that, when it comes to interest rates, the long-term interest rate (unlike the short-term interest rate and the slope of yield curve) has a substantial positive impact on bank NIMs. This may be because of the large macroeconomic and financial shocks that affected banks, or because banks have changed their business models and the structure of their balance sheets. Market Overview Analysis by Sober Look covering: BP PLC, Total SA, SIMPLE SA. “In the short term, banks can outperform on the yield curve steepening that should accompany any further post-pandemic return-to-normal trade,” Chris Wood noted. This is beyond the remit of this article. Instead, the slope goes the wrong way – it is negative for the UK confirmed by a simple regression – suggesting that an increase in the slope of the yield curve lowers the NIM.   and the 10-year note This isn’t just a UK phenomenon — NIMs in other countries have remained relatively stable since the global financial crisis too, despite falling long-term interest rates in these economies (Figure 4). The long rate has a higher coefficient and is statistically significant for most countries. Another important factor is prudential policy – notably the requirement to maintain an adequate level of liquidity. The benchmark 10-year yield US10YT=RR, which climbed as high as 1.125% for the first time since March, was last up 4.4 basis points at 1.1153% and the yield curve steepened. The secular bond bear market starting from 1980 saw long-term bond yields fall across the globe but net interest margins stabilized after the 2007-2009 recession. This would give relief to banks suffering from the weight of low interest rates in the hope that stronger banking activity would stimulate the broader economy. Shares of Moderna Inc. undefined were up 1.3% in premarket trading on Monday after the company said it plans to launch new development programs using its mRNA technology that will focus on developing vaccines for seasonal flu, HIV, and the Nipah virus. This activity is typically profitable as short-term interest rates are usually lower than long- term interest rates. If the structure of their balance sheets changes, so too might these results. Indeed Table 1 (below) shows that this negative relationship arises in all countries in our sample bar the US, a point observed by a Liberty Street Economics blog post. Even as longer-term Treasury yields plummeted as investors focused on the return of principal (as opposed to return on principal), the Federal Funds rate dropping by 150 basis points led to a steepening of the yield curve. Also, OCBC's New CEO, CDL Shares And Signal and ninety-nine more episodes by Interviews, free! To push the spread toward positive territory, the central bank promised to keep the 10-year Japanese government bond yield at zero. 4. For example, NIMs capture much more than just the gains of maturity transformation. Similar principles apply to building societies and many other financial intermediaries. While, for the most part, higher long-term rates have juiced earnings. The report he cites … Yield Curve Steepened Now Since banks borrow money at short-term rates and lend capital at long-term rates, steepening of the yield curve bodes well for bank ETFs. Banks “focused instead on the greater likelihood of Congress approving a big spending package to limit the economic pain from the pandemic, as well as a steepening yield curve, meaning a … But notice in the top chart above that the relative strength ratio peaks at the same time as the 10-2 spread. A challenge to the conventional wisdom, Montagu Norman and the transformation of the Bank, There’s more to house prices than interest rates, Global real interest rates since 1311: Renaissance roots and rapid reversals. Moderna's stock has soared 489.1% over the last year, while the S&P 500 undefined is up 19.7%. Sources: World Bank, OECD, SNL database and Bank calculations. Firstly, it is encouraging, from a prudential viewpoint, to read that the Bank of England is conducting in depth research into the impact of a steeper yield curve. The views expressed here are those of the authors, and are not necessarily those of the. Comments will only appear once approved by a moderator, and are only published where a full name is supplied. Post was not sent - check your email addresses! As part of its corporate update, Moderna said it had about $5.2 billion in cash as of Dec. 31, compared to the $1.2 billion in cash it had at the same time a year ago, and it expects to generate at least $11.7 billion in revenue in 2021 for its COVID-19 vaccine based on advance purchase agreements. The graph is plotted with … credit risk). Even with the Federal Reserve expected to keep interest rates low, the yield curve has been steepening as investors try to look beyond the pandemic. Enter your email address to subscribe to this blog and receive notifications of new posts by email. Yes, banks outperformed the S&P 500 by 82 percentage points from 2000 to 2004 and by 73 points from 1980 to 1986, periods when the yield curve was steepening. But they also … The long rate in many economies has fallen gradually over time since the late 1980s. We find no systematic positive relationship between the slope of the yield curve and NIMs. The impact of these factors diminishes as the economy slows in response to significant monetary tightening. This reflects an attempt to widen the scope of economic debate, by increasing the potential for links between business economists and those working in other fields, notably the academic and government sectors. The yield … The yield curve’s beneficial impact on bank margins passes for conventional wisdom, the researchers said. “We believe the continued weakness of … Are you saying that the yield curve will steepen without the LT rate going up? In my lengthy experience of treasury management, international factors (especially the consensus forecast path of the US and Chinese economies) are significant drivers of longer-term sterling fixed interest rates. In light of this caveat it is hard to say with certainty whether this observed relationship between long rates and NIMs will reinstate itself or not; it is too early to tell.   and its shorter-term peers were negative. Member, Association of Corporate Treasurers; Member, Society of Professional Economists, Independent Economic and Treasury Advisor. The paper raises a number of important points, and the following observations may be of relevance. +0.32% Net interest margins are calculated as the interest banks earn on their assets—e.g. These changes no doubt will have some impact on the slope of the yield curve and its relationship with NIMs, but those are beyond the scope of this article. To refresh, the "yield curve" I use is the difference between the 10-year Treasury bond yield and the 2-year Treasury bond yield. This finding helps to explain why an upwards parallel shift in the yield curve is good for net interest margins (because while the slope does not change the long rate goes up). Read Sober Look's latest article on Investing.com TMBMKJP-10Y, 1.153%. In this scenario of a slowing economy, aggregate demand for bank loans – and hence bank profitability, diminishes. A key factor is financial market rationale for both a steeper yield curve and a higher level of long- term rates. Figure 3 shows that while that relationship held in the UK prior to the financial crisis, it appears to have broken down since – as the NIM has flattened out in recent years, despite the continued fall in the long rate. For example, NIMs also reflect the rewards banks collect for bearing different types of risk (e.g. Figure 1: Illustration of maturity transformation. It’s in part why the Bank of Japan tinkered with its loose monetary policy in a bid to steepen the yield curve in September 2016. Equities tend to trend downward for first half of yield curve steepening. We find that the long rate is more important than the short rate in determining NIMs in a very simple regression model. Sunny Oh is a MarketWatch fixed-income reporter based in New York. on the loans they make — minus the interest they pay out on their liabilities – e.g. The short rate is closer to zero and is insignificant for most countries, apart from Italy and Spain. Positive relationship between the slope of the authors, and are only published where a full name supplied. Will expand net margins and increase banks profits of assets and liabilities of balance. ‘ mixed steepening yield curve good for banks and ‘ messy ’ —but there ’ s policy and Strategy Division loans – hence... Steep yield is normally associated with steepening yield curve good for banks eventual significant slowdown in the bank ’ s policy Strategy... 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