Narrowing Yield Spread Weighs on Regional Banks

Arthur Hill

Arthur Hill

Chief Technical Strategist,

The Regional Bank SPDR (KRE) failed to hold its flag breakout and then broke support with a sharp decline this week. It would now appear that KRE formed a rising wedge that peaked below the January high. This week's wedge break signals a continuation of the prior decline and projects a move below the May low. This week's high and the trend line break to mark a resistance zone in the 40-40.5 area. With the upswing reversed, chartists can also consider a larger bearish pattern taking shape. Combined with a relatively equal high in January, a large head-and-shoulders reversal pattern could be taking shape with neckline support in the 36.5 area. 

The overall stock market remains strong with the S&P 500 near all time highs and the Finance SPDR (XLF) hitting a 52-week high this month. Why are regional banks underperforming and breaking down? The spread between the 10-year Treasury Yield ($UST10Y) and the 2-year Treasury Yield ($UST2Y) may be to blame. The second chart shows a 1.99 difference between these two yields, which means the 10-year Yield is 1.99% more than the 2-year Yield. The yield curve is still very positive and this bodes well for the economy overall, but the difference between the two has narrowed significantly this year. The 10-year Yield fell, the 2-year Yield rose and the Yield Curve 10YR - 2YR ($YC2YR)) fell to its lowest level since June 2013. Banks make money by borrowing at short-term rates, lending at long-term rates and capturing the difference. This difference is less and this could be weighing on regional banks. A break above 2.2 in the Yield Curve (10YR - 2YR) would suggest that the spread is widening again and this would be positive for regional banks. 

Good trading and good weekend!
Arthur Hill CMT

Arthur Hill
About the author: , CMT, is the Chief Technical Strategist at Focusing predominantly on US equities and ETFs, his systematic approach of identifying trend, finding signals within the trend, and setting key price levels has made him an esteemed market technician. Arthur has written articles for numerous financial publications including Barrons and Stocks & Commodities Magazine. In addition to his Chartered Market Technician (CMT) designation, he holds an MBA from the Cass Business School at City University in London. Learn More