Why Have Bank Stocks Had Such a Bad Two Weeks? A Flattening Yield Curve

Now is supposed to be a good time to be a bank.

The largest lenders in the United States are enjoying ballooning profits. The Trump administration has removed rules on banks and more deregulation is likely to come. The economy is in one of its strongest patches since the financial crisis, and the Federal Reserve is raising rates.

But it would be hard to tell all that by looking at their share prices over the past two weeks.

Though it was up Thursday, the S&P 500 had fallen for 13 straight trading days and was off 5.9 percent over that period. The KBW Bank Index was down the same percentage. Shares of Morgan Stanley had declined 9.1 percent from June 8 through Wednesday’s close, JPMorgan Chase & Co. was down 7.1 percent and Goldman Sachs Group Inc. was off 5.7 percent.

So why are bank stocks struggling? A flattening yield curve.

Over the past several years, bank shares have moved with interest rate expectations. When investors believe rates will climb, shares of banks rise as well and vice versa. The reason for that is simple. Banks are typically more profitable in a rising rate environment, and after years of historically low rates crimping the bottom lines of banks, investors cheered any signs that rates would move higher.

But it is currently a bit more complicated than that. The yield curve — basically the difference between interest rates on short-term U.S. government bonds and long-term government bonds — is often considered a good proxy for the profitability on bank lending. Usually, long-term interest rates are higher than short-term ones. Because banks borrow at the short end and lend at the long end, the greater the difference between the two, the more profitable bank lending can be.

But the yield curve is currently flattening. The spread between two-year and 10-year U.S. Treasury notes is at its narrowest level in more than a decade.

And that could bite into the margins of banks.