Why one proxy for the health of the U.S. economy just logged its worst losing streak ever

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It was unlucky 13 for financials on Wednesday, with a popular banking sector exchange-traded fund extending its longest ever losing streak and underscoring the headwinds facing lenders despite signs of a strengthening U.S. economy and the rollback of unfavorable regulations.

On Wednesday, the Financial Select Sector SPDR ETF












XLF, -1.24%










also known as the XLF, marked its 13th consecutive drop. The ETF, which comprises some of the biggest banks, including JPMorgan Chase & Co.












JPM, -1.54%










Citigroup Inc.












C, -1.28%










and Bank of America Corp.












BAC, -1.05%










already registered its worst losing streak ever on June 21, when it put in a ninth consecutive drop, according to WSJ Market Data Group.

The retreat by XLF highlights the broader decline in financials, which have been beset by a number of geopolitical headwinds, including mounting global hostilities around trade, but has accelerated as the yield curve, which is closely watched for an early warning on potential recessions, comes into focus.

An environment in which yields on benchmark Treasurys, specifically the 10-year note, remain historically low, is a negative for banks that borrow on a short-term basis and lend on a longer-term basis. Yields and bond prices move in opposite directions.

But it is the yield curve that has rattled investors nerves and the appetite for bank stocks. That’s despite expectations for strong demand as investors were expected to rotate out of highflying technology and internet stocks to banks as the Federal Reserve raised benchmarks rates off crisis-era lows.

The Treasury yield curve maps yields across all maturities. The curve flattens when the spread between short- and long-dated yields narrows. An inverted curve, in which short-dated yields exceed longer-dated yields, has preceded every recession for the past 60 years.

Currently, the spread between the 10-year Treasury












TMUBMUSD10Y, +0.29%










 yield and the 2-year Treasury












TMUBMUSD02Y, +0.17%










stands near 31 basis points or 0.31 percentage point, the narrowest since 2017.

Source: FRED


“The metric of the moment is the yield curve,” wrote Mike Mayo, bank analyst at Wells Fargo, in a June 19 note. “Investor concerns about the shape of the yield curve are warranted if the curve becomes inverted (short-term rates higher than long-term), which is often seen as a harbinger of a recession and the onset of a credit cycle.”

Jeff Harte, financials analyst at Sandler O’Neill + Partners, told MarketWatch that the threat of a trade war, however, is weighing on banks and the broader market due to the potential to whack the domestic and global economy, further driving long-dated bond buying.

“Banks are a proxy for the economy because they finance the economy,” Harte said. “A trade war would not be good for the economy and especially not for companies like Goldman Sachs and Citigroup,” he said, referring to the some of the largest money-center and investment banks.

However, neither Harte nor Mayo believe that banks are likely to remain in the doldrums in the second half of 2018.

Mayo believes that if the yield curve inverts, it may not result in a recession because it is partly a result of a dynamic created by global central banks, including the Fed, who moved to lower borrowing costs and drive demand for riskier assets to avert a financial crisis that took root in 2008.

“Not all flat yield curves are created equal, such as when banks outperformed in the 1960s, 1990s, and 2017,” Mayo wrote. He notes that financial institutions are well capitalized and are in solid shape.

Indeed, on June 21, the Fed determined the largest U.S. banks were healthy enough to withstand a severe economic downturn as the industry posts record profits and prepares for a wave of regulatory relief.

Banks are set to receive approval to deploy capital to investors on Thursday as a part of the second leg of its banking “stress tests,” which were implemented in the aftermath of the 2007-09 financial crisis.

“Historically high capital return should go even higher after the Fed approves bank capital plans on June 28,” Mayo wrote.

For Harte’s part he concurs with the notion that an inverted yield curve doesn’t automatically mean a recession. “Even if we did [invert], the past may not be prologue,” he said.



Source : MTV