Bank stocks may be running ahead of reality—again.
Bank stocks, especially for the biggest firms, moved higher Friday on an October jobs report that fortified hopes higher interest rates would soon be here. Many investors view the big banks as a way to play a rising-rate environment, reflecting the fact they have positioned themselves to gain from such an upward move.
Yet with shares of many of the biggest banks now up 9% to 10% from a month ago, investors probably shouldn't expect to see much more of a lift. Shares of Bank of America, considered by many to be the "purest" interest-rate bet, are up 14%. If anything, the risk is that interest rates prove less buoyant than expected, holding back bank earnings.
The problem isn't that investors are misreading the jobs report. The combination of strong job growth, falling unemployment and rising wages does indeed set the stage for the Federal Reserve to move its target rate higher in December.
It's that a single rate increase isn't likely to deliver sharply better results for banks. At best, moving the overnight target rate a quarter of a percentage point higher could put an end to the deterioration of net interest margins that has afflicted banks for several years now.
For the big U.S. banks, however, significant earnings improvement would require far more. The Fed would have to follow the script of past tightening cycles, steadily raising rates every meeting or every other meeting. This would result in a steeper yield curve as well as an increase in bond trading flows and more sales for interest-rate hedging products. Net interest margins would really improve.
That's not likely to be what unfolds after the interest-rate curtain lifts. A second rate raise could be several months in the offing, as the Fed takes a wait-and-see approach following its first move higher. Bad news during those months could push further moves even farther into the future.
Even though rates on the longer end of the curve are already moving higher, the benefit to banks may be muted as the yield curve remains relatively stable. The two-year Treasury yield has moved sharply over the past month, to 0.91% from 0.61%. The 10-year yield has moved from 2.06% to 2.33%.
That puts the spread, or difference, between the two, at 1.42 percentage points. A year ago, this was at 1.84. So this part of the curve actually flattened.
Things have gotten better for banks. But investors shouldn't get carried away.
Write to John Carney at john.carney@wsj.com
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