Just weeks into 2018, banks rethink year-end bond yield forecasts

Just weeks into 2018, banks rethink year-end bond yield forecasts

The Fed's rate hike process has helped USA banks gradually improve their net interest margin (NIM) figures steadily over recent years - helping this key operating metric up from the record-low figures seen over 2014-15. This was against the backdrop of a strongly rising trend thanks to very positive economic conditions and President Trump's business friendly policies.

Sure enough, bond yields hit a four-year high Friday. This, combined with a very strong start to this year of 7.5%, very high levels of short-term investor optimism and lots of talk of a "melt up" left the United States share market overbought and highly vulnerable to a correction, which we may now be starting to see. Investors are anxious about evidence of rising inflation in the U.S. Increased inflation might push the Federal Reserve to raise interest rates more quickly, which could slow down economic growth by making it make it more expensive for people and businesses to borrow money.

The CBoe Volatility index.VIX closed at its highest since August 2015.

Share prices began falling Friday, when USA employment statistics showed that wages in the country rose last month by the fastest clip in eight and a half years. This makes stock investments less attractive.

Some investors had been reluctant to stand in the way of the selloff, which has sent 10-year yields up from a low of 2.654 percent last Monday, until they see signs of stabilization. So the two key questions are how severe the back up in bond yields will be and whether a recession is approaching?

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Rising inflation isn't always a bad thing.

The 10-year notes last rose 38/32 in price to yield 2.7093 percent, down from 2.852 percent late on Friday.

Rising bond yields means higher borrowing cost for companies and an alternative investment option for traders.

The S&P energy index led the decliners among the 11 major S&P sectors, with a 2.03 percent fall. That caused some on Wall Street to suggest the Fed could hike rates four times this year instead of the three that was expected. Stocks were hit hard across the board with only technology surviving Monday's bloodletting in the Dow.

Bristol-Myers Squibb was up 2.2 percent after the drugmaker said a late-stage trial for a lung cancer drug met its main goal. Notably, this compares to a much higher sensitivity factor of 50% for peers Wells Fargo and Capital One.

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The S&P 500 in January saw its 10th consecutive monthly gain, the longest streak in 59 years. While rising interest rates are largely considered a negative for most industries, the USA banking sector will be one of a few industries that will see a sizable benefit from more rate hikes.

The downdraft raised fresh anxieties among Americans who have seen their retirement savings and household worth march steadily higher without any of the gyrations that are part of a normal market cycle. In fact, the same applies to Australian shares. "Now they are saying we will take out the steroids, because it could have side-effects", said Nilesh Shah, MD at Kotak AMC. The Fed Funds rates of 1.25 - 1.5% is still well below nominal growth of just over 4%. Bond prices sank, leading investors to sell comparatively expensive equities. Hard for that to happen when we've had the QE free lunch for so long, and now the large tax cuts to corporations. Inflation here we come!

As a result, earnings growth is likely to remain strong in the year ahead.

In a statement following the two-day policy meeting, the Fed said "inflation on a 12-month basis is expected to move up this year", predicting it will stabilise around its 2% target over the medium term. Silver dipped 4 cents to $16.67 an ounce. Surely that must be bad for profits?

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