How Bank Of America Moved After Fed Hikes

Chris B Murphy profile picture
Chris B Murphy
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Summary

  • The Fed is widely expected to hike rates during the two-day meeting ending on Wednesday.
  • Bank stocks like Bank of America have corrected at least 8% following the last three Fed hikes.
  • The 10-year Treasury yield also corrected taking bank ETFs down with them as global capital flows from regions with expanding balance sheets flood into Treasuries.

The Federal Reserve Bank is widely expected to hike interest rates tomorrow for the fourth time since December 2015. Both the 10-year yield and bank stocks like Bank Of America Corporation (NYSE:NYSE:BAC) have corrected lower following the last three Fed hikes. Bank of America's stock price is heavily influenced by yields since the bank's loan book is comprised of a substantial amount of variable rate loans.

Although the market is on Fed watch to see if Yellen and company hike rates, the verbiage following the meeting will be more important since it may contain indications of winding down the enormous $4.5T Fed balance sheet.

The Fed Chair, Janet Yellen, is unlikely to make any bold statements about balance sheet reduction since Yellen has stated many times that the Fed will go about hiking at a gradual pace.

It may seem surprising (at least it was to me) that the 10-year yield has fallen in the days following the last three Fed hikes. As a result, bank stocks like Bank of America have corrected in lock step.

Other banks are influenced by the Fed-induced yield correction as well like JPMorgan Chase & Co. (NYSE:JPM) and bank ETFs like the Financial Select Sector SPDR ETF (NYSEARCA:XLF).

If you follow my articles on Seeking Alpha, you know that my writing centers around investment risk management. Since most stock brokers studied finance in college, they often focus more on P/E ratios and less on economics and global capital flows.

However, these large flows from big money (hedge fund or central bank money) create the overall trend in the markets influencing the value of bond yields, currency exchange rates, and ultimately equities like bank stocks. By monitoring the trends and the large flows of global capital, we can help avoid that dreaded "bad trade" or avoid getting stopped out of a good trade that eventually might have been a winner in the long run.

This analysis is not meant to sound negative on banks in fact, I believe banks should do well in both a rising growth and yield environment.

Below is the 10-year yield volatility following the last three Fed hikes.

  • The most shallow correction in the 10-year yield was 11% in December 2016.
  • Most of the corrections were preceded by a rally in yields. However, the Fed meeting tomorrow is different. We're currently sitting at a 2.20% 10-year yield. As a result, it may not take much to move yields lower since the trend is bearish.

Why do yields fall after a hike in interest rates?

  • Lowered expectations of U.S growth due to weak Q1 growth and waning optimism in President Trump's business friendly agenda getting passed this year has weighed heavily on the 10-year yield.
  • The 10-year yield if you recall is largely driven by inflation and growth expectations, while the two-year yield is driven by Fed action or hikes. This is why sometimes we see the two-year yield rise after the Fed hikes, while the 10-year yield falls as investor optimism surrounding growth wanes. If you need a guide on how the two-year and 10-year move historically, save my prior article (The 2-Year And 10-Year Spreads And The Different Messages) as a reference guide for future use.
  • Expanding central bank balance sheets overseas are pressing Treasury yields down. As mentioned earlier in the article, global capital flows are critical to monitor and these flows out of low-yielding government bonds in Europe and Japan and into the U.S. bond market have pushed up U.S. bond prices and lowered yields.

Here's Bank of America's stock price reaction to the last three Fed hikes:

  • In the chart above, I removed the 10-year yield price action but left the drawings from the previous chart. Next, I added BAC to the chart without touching anything else.
  • As we can see, the BAC corrections line up very well with the fall in yields post-Fed hikes. The yield corrections are met with a substantial move in BAC (green boxes) with at least an 8% move lower in the days following the meeting.
  • Again this analysis isn't meant to scare anyone off from investing in banks. Instead, it's designed to make you aware of the impending volatility in the markets following the Fed meeting. As a result, risk management tactics (wider stop-loss orders, option strategies, etc.) may need to be employed.

Here's the 10-year yield, Bank of America, with JPMorgan Chase and the XLF Financial ETF.

  • In the above chart, BofA, with its large variable loan portfolio, is not the only bank exposed to yield volatility.
  • Even JPMorgan Chase and its balanced approach to earnings (both non-interest income and net interest income) is susceptible to corrections following any large move in the 10-year yield. ETFs too are influenced by yields despite containing many stocks from the financial sector.

Going forward:

Global capital flows into the U.S. are driving down yields and somewhat offsetting the Fed hikes or at least, offsetting the Fed's plans for steepening the yield curve in their effort to get banks to lend more money and normalize the Fed's interest rate policy.

  • For investors, we must watch how yields play out and how banks react following the Fed meeting. We must also watch the Fed statement for any change in language regarding the Fed's balance sheet.
  • In the coming days following the Fed meeting, it's likely volatility will spike resulting in investors getting stopped out of their trades by a possible pullback in yields and banks.
  • However, in the medium-to-long run, yields should bottom and bounce higher, with an injection of economic growth, taking bank stocks like Bank of America along for the ride.

Good luck.

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This article was written by

Chris B Murphy profile picture
3.66K Followers
Hello. I'm a financial writer/blogger & market risk analyst with 15 years in the financial services industry including over 10 years on trading desks of two major banks. --------------------------------------------------------------------------------------------------------------------- My Top-Down meets Bottom-Up Approach to financial analysis includes: ----------------------------------------------------------------------------------------- How Macro Trends & Economic Indicators, Bond yields, Capital flows, & The Fed - Drive Sectors & ultimately Individual Stocks. - Financial analysis of Bank stocks, Commodities, Industrials, & Tech. - Former currency risk advisor to Corporates, with Options and risk policy experience.- Published Work includes: Financial analysis (Investopedia); - Retirement Income (RetirementIncomeAnalyst.com) & Wealth Management Firms. - Hold an Economics degree with a concentration in Finance (University of Rhode Island).
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In full disclosure, this article is not a comprehensive analysis of Bank of America or bank stocks. I am not a financial advisor, and we will only be analyzing a few of the many fundamental and economic factors that go into driving the stock price and profitability of BAC. Before making any investment decision, please contact your financial advisor. And of course, any analysis of past performance does not guarantee future results.

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