By Tim Seymour
As the momentum in the economy inspired by the elections joined forces with real inflation growth, we started to see TIPS (Treasury Inflation Protected Securities) go through some selling exhaustion and this could be a good sign for Rates and Banks.
The argument is that TIPS tend to lead everything and were a great preview of the thrust higher on growth expectations, as inflation expectations hit 13-yr highs. Break evens on TIPS have fallen another 4bps today and it seems we are truly unwinding the election expectation in the UST curve. Now what?
Since TIPS peaked we have moved in the exact opposite direction since April started, for reasons that are well flagged to all and are not worth addressing. What we are highlighting is that the selloff in TIPS and the flattening of the yield curve (see attached) potentially set up for a positive trade in banks into Q1 earnings where suddenly expectations are being ratcheted down.
To be clear, banks were benefitting from increased inflationary pressures, a Fed on the offensive, and better industrial data that was coming through well before we could have ever dreamed of a Trump presidency and all that this is then promised on policy that was rates-supportive.
Rates are now at the bottom of the range and the curve has flattened 2-10s down to 107 or 5bps removed from where we were on November 7th. The trade higher for banks is now pricing in very little on the interest rate sensitivity side and that is running contrary to where we see global growth, CB activity and the slow normalization of the curve we were seeing pre-elections.
While all we hear about is the fall-off in loan activity in Q1 and rising credit delinquencies in credit cards and auto loans, banks are lean, mean, and operating with greater efficiency in a world where regulators are not focused on yesterday's transgressions anymore. At a time when valuations are challenging, banks are not the place where you are needing to justify the multiple.