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. In the wake of the COVID-19 pandemic, financial markets experienced almost unprecedented levels of volatility during the month of March. 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 … 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. There have also been a number of occasions when political factors have impacted on long term UK interest rates – both short term fears and longer term UK political / geopolitical risks. The paper makes reference to banks. 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. Comments will only appear once approved by a moderator, and are only published where a full name is supplied. It is worth remembering that the results are driven by the average maturity and composition of assets and liabilities of bank balance sheets. Understanding Curve Steepener Trades . 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 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. Overall though, we find that a steepening of the yield curve is generally associated with a fall in the NIM (Table 1). We find no systematic positive relationship between the slope of the yield curve and NIMs. But notice in the top chart above that the relative strength ratio peaks at the same time as the 10-2 spread. Many banks hedge long term interest rate exposure, thus matching their variable rate liabilities with variable rate assets (fixed interest assets hedged by interest rate swaps or more sophisticated hedging mechanisms). The conventional wisdom follows from  banks’ fundamental business model— to act as maturity transformers by borrowing short term (e.g. 0.148% This activity is typically profitable as short-term interest rates are usually lower than long- term interest rates. 4. The short rate is closer to zero and is insignificant for most countries, apart from Italy and Spain. Figure 1 illustrates this with the aid of a stylised yield curve. credit risk). 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. This post was written whilst Oliver Brenman was working in the Bank’s Policy and Strategy Division. 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. The final observation. Our results suggest that it is the level of long-term interest rates, rather than the slope of the yield curve, that drives banks’ NIMs. Figure 4: Post crisis bank net interest margins have remained remarkably stable, despite significant falls in interest rates. Our simple empirical results suggest that there would be a corresponding fall in bank NIMs. the interest they pay to savers. But they also … So it is really a steepening yield curve that is good for small cap outperformance, not just a steep one. A very steep yield is normally associated with an eventual significant slowdown in the economy, as the monetary authorities aggressively tighten monetary policy. 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 … Likely too early to expect a bottom on the S&P 500. 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 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. From a bank profitability viewpoint, the slope of the yield curve can often be a more significant, longer term, than the level of long -term rates. The bank … Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. Back then, the spread between the 10-year yield For example, NIMs also reflect the rewards banks collect for bearing different types of risk (e.g. Motivated by this discovery, we sought to inspect how the individual components of the slope of the yield curve (the short and long rate) affect NIMs. Stemming from this understanding of maturity and liquidity transformation Bill English  observes that this intuitive positive relationship has been the conventional wisdom for some time. TMUBMUSD10Y, Another important factor is prudential policy – notably the requirement to maintain an adequate level of liquidity. This could reflect changing bank business models or simply the shifting composition of securities on a bank’s balance sheet, they said. 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. That creates the possibility of the yield curve steepening at the very same time banks attempt to break out of their range. A steeper yield curve promises improved interest margins for banks, prompting strong gains for financial stocks. 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. It provides a clear, visual image of long-term versus short-term bonds at various points in time. "The uniquely challenging year of 2020 for all of society proved to be an extraordinary proof-of-concept period for Moderna," CEO Stéphane Bancel said in a news release. Meanwhile, the slope of the yield curve is defined as the difference between the long-term interest rate (10 year government bond) and a short-term rate. 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. Listen to What Does A Steepening Yield Curve Mean And How Do Investors Generally Interpret It? A look at the price chart shows that banks got trapped in a range as the yield curve flattened. 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). For example, NIMs capture much more than just the gains of maturity transformation. A rise in long- term rates is good for banks short term, due to the factors referred to in the paper. Moderna's stock has soared 489.1% over the last year, while the S&P 500 undefined is up 19.7%. The yield curve’s beneficial impact on bank margins passes for conventional wisdom, the researchers said. This suggests there is much uncertainty about the future relationship between interest rates and bank profitability. 1.153%. on the loans they make — minus the interest they pay out on their liabilities – e.g. To push the spread toward positive territory, the central bank promised to keep the 10-year Japanese government bond yield at zero. 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. This initiative may well enhance the links between the Bank of England and business sector economists – especially given that former BOE Deputy Governor, Professor Charles Bean, is a Deputy President of the enhanced professional body. Fed yield curve control: More false optimism. Yet the yield curve argument is popular because it conforms with the understanding of how banks make money. After the financial crisis, the link between higher long-term interest rates and strong bank earnings appeared to break down, the researchers said. 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. We find that the long rate is more important than the short rate in determining NIMs in a very simple regression model. To refresh, the "yield curve" I use is the difference between the 10-year Treasury bond yield and the 2-year Treasury bond yield. "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. One penultimate observation. Equities tend to trend downward for first half of yield curve steepening. Copyright © 2021 MarketWatch, Inc. All rights reserved. The conventional wisdom amongst financial market observers, academics, and journalists is that a steeper yield curve should be good news for bank profitability. XLF, 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. This is beyond the remit of this article. A steeper yield curve is good for banks Banks typically borrow short term and lend longer term, which results in maturity transformation. Figure 2: Simple plot of the slope of the yield curve and average bank NIMs in the United Kingdom. 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 … This will expand net margins and increase banks profits. The yield … Sources: World Bank, OECD, SNL and authors calculations. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees. In this scenario of a slowing economy, aggregate demand for bank loans – and hence bank profitability, diminishes. 1. 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. 0.039% “We believe the continued weakness of … Sorry, your blog cannot share posts by email. 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. Figure 1: Illustration of maturity transformation. So if the yield curve steepens, bank profits should rise. A key factor is financial market rationale for both a steeper yield curve and a higher level of long- term rates. When the yield curve is steep, banks are able to borrow money at lower interest rates and lend at higher interest rates. 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. The views expressed here are those of the authors, and are not necessarily those of the. This article challenges that conventional wisdom. No signup … And the flattening of the yield curve … 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. The net interest margin is the difference between the interest banks earn on the loans they make and the interest they pay to savers. 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. 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