This article is written exclusively for Investing.com
Financial stocks have come under considerable pressure over the past week, which could be the start of something much bigger. Bond yields have fallen at the long end of the yield curve, causing spreads to narrow. Widening spreads and rising interest rates helped boost bank shares for several months; tightening spreads and falling interest rates will push these stocks down.
Add to this recent news that JPMorgan (NYSE:) and Citigroup (NYSE:) expect second-quarter trading earnings to be lower than in previous quarters. Activity in the broader stock markets appears to have calmed dramatically in recent months, and lower trading volumes will not help these banks as we head into the third quarter.
Spreads narrowing
The main problem for the banks is falling interest rates on the long-term and rising interest rates on the shorter side. Yields, for example, have fallen by more than 20 basis points to 1.5% since May 13. Meanwhile, yields have increased by about 6 bps to 21 bps in the same time. This narrowed the spread to 1.29% from a 1.55% peak on May 13.
10-2 Year Treasury Spread Daily
As the spread continues to compress, the bull run in banks may be over, and these stocks will fall even more. While it may seem hard to believe, given the amount of talk about inflation and rising rates, there is a real possibility that this is happening.
The Pivot
The Fed made a significant decision on Wednesday when their the quarterly projection showed two rate hikes by 2023. The forecast showed federal funds rates rising to 60bp overnight. That is much higher than the current 21 bp of the 2-year bill. That means, over time, markets will likely begin to anticipate interest rate hikes. That anticipation will drive yields up the short end of the curve.
Furthermore, as long as market forces remain in play and central banks like the Fed and ECB continue to buy longer-dated bonds, interest rates at the long end of the curve are likely to remain subdued. Commodity prices also fall sharply, and if they rise further, those commodity prices will fall even more. This means that the recent rise in inflation will slow down, driving interest rates even lower in the long run.
Technique broken
The technical side of the banks suggests that there may be more pain at the bottom. JPMorgan is already showing several bearish trends after breaking a critical uptrend that started in late 2020. This, coupled with a relative strength index now trending lower, suggests the stock may have reversed its trend and appears to be heading for the next level of support, around $146.
The Trends in Citigroup are just as bad, with the same long-term uptrend broken now and a relative strength index reversed lower. Both indicate that Citigroup is likely facing a reversal of its long-term trend, and a break below the $68.50 support could send the stock towards around $63.
A financial sector failure could be a major problem for the wider market if this trend continues. At the end of May, the financial sector contributed nearly 3.1% to the 12.6% return, based on data from S&P Jones Indices. If financials continue to fall, the broader index will need another sector to catch up. It may once again fall on the shoulders of technology.
