The shape of the Treasury yield curve, which plots the yields of the various debt securities issued by the U.S. government, often reflects investors’ perceptions of the health of the economy and the outlook for inflation.
With the announcement of Jerome Powell as the new Federal Reserve Chair, banks are likely to see a battle between a boost from deregulation supported by the new Fed leader and the challenge of a flattening yield curve as monetary policy is likely to remain on course.
A steepening yield curve is seen as a boon to banks, as they borrow on lower shorter-term rates and lend on higher long-term rates, which helps generate profits through increased net interest margins. But the curve has flattened under current Fed policy which is expected to continue under Powell, who has worked alongside current Fed Chair Janet Yellen for the past five years.
A steeper curve, when long-term yields rise relative to shorter-dated yields, typically augurs brisker economic growth and inflation. A flatter one, when the gap between short and long term yields narrows, most often occurs as the Fed is raising short-term interest rates as it is now, and signals a muted outlook for both growth and inflation.
However, investors are likely to welcome Powell’s view on deregulation, as he has gone further than his colleagues in calling to relax some of the rules put in place to limit banks in the wake of the financial crisis.
The S&P bank index jumped nearly 18 percent in November 2016 in anticipation of U.S. President Donald Trump’s policies to stimulate the economy.
It then cooled in 2017, with a gain of 2.9 percent through the end of August. Gains have picked up steam since then, as the index has climbed more than 10 percent, buoyed by a rise in the benchmark U.S. 10-year note yields, quarterly earnings results from financials and increased expectations for a rate hike by the U.S. Federal Reserve in December.
After the announcement of Powell’s nomination on Thursday, the bank index added to gains, to close out the session up 0.8 percent, boosted by a 1.2 percent gain in Bank of America and JPMorgan’s 0.7 percent rise.
The nomination will go through the Senate for confirmation and, if confirmed, Powell will take the reins of the central bank when Yellen’s term expires in early February.
Powell as leader of the Fed is seen as a boon for Wall Street as the key banking regulator continues its review of a raft of rules for supervision and examination introduced after the 2007-09 financial crisis.
Regarding the Fed’s future monetary policy path, Powell’s appointment is expected to provide investors with some certainty as his views are seen as more in line with those of Yellen. A Fed governor since 2012, he has yet to cast a dissenting vote against the Federal Open Market Committee’s decisions on monetary policy.
“Powell will probably have a positive effect because while he is gradual on the unwind process, he is a fan of deregulation”, said Art Hogan, chief market strategist at Wunderlich Securities in New York.
Working against banks, however, has been a flattening of the yield curve, which could dampen profits. The yield curve between five-year notes and 30-year bonds was 81.7 basis points on Friday, its flattest level last seen in late 2007.
