Crush Financials: Take your Cue from the Curve

Hey There Income Hunters,


Have you ever heard the phrase, “Borrow short and lend long?”


It’s the winning formula for banks, especially now as the interest rate curve resembles a double black diamond ski slope … 


Check out the bad boy below. You really have to sharpen your edges to make it down a slope like this in one piece (especially skiing in the Northeast, which is known for its ice and rocks) …



But seriously, if the 2-year/10-year yield spread is not on your dashboard, it should be.


This spread is a very important signpost for liquidity conditions and bank profits.


It’s also the reason the prime brokers were fighting over Archegos CEO Bill Hwang and his business over the past few weeks …


You see, when the yield curve is steep — meaning the 2-year rate is much lower than the 10-year rate — the profit margins for banks are HUGE.


Here’s why… 


Banks are sitting on so much free cash from the massive spending and deposits they have taken in … while at the same time longer-term interest rates are rising.


Banks, then, are borrowing at zero and investing at 3%, 4% or even higher because of the steep rise in yields as the curve extends out.


As recently as 2019, the 2-year/10year yield was .25% — and now it’s 1.60%


That becomes the profit margin for banks that use deposits to make longer-term loans.


Of course, when the going is good, greed rears its ugly head …


Which leads us back to the Archegos story as the process was fraught with mutual hazard, and I’ll cover more of that tomorrow.


Back to the curve, check out how tightly correlated the SPDR Sector Financials ETF (Ticker: XLF) tracks the 2-year/10-year yield spread …



What I read here is the bond supply is rising and bond yields are expected to continue to rise as inflation moves higher …


In the short-maturities the Fed has told us multiple times that rates will stay at zero through 2022.


So the curve will continue to steepen and therefore financials are a sector you want to be long …


That actually reminds me of the Visa (Ticker: V) trade I put on in the financial sector and wrote about recently.

On March 23 Visa was trading at $205 and I put on a 205/215 call spread to September.


Today, Visa is trading at $218 … 


Visa is an awesome company and that will crush it as the economy reopens. I’m looking for a pullback to $213 to add a 215/225 call spread, as well.


Bring It Home


Watching the 10-year yield and the 2-year/10-year curve could save you a lot of money AND make you a lot of money.


That’s because interest rates and the slope of the yield curve have knock-on effects across all markets.


As we head into the second half of the year and the economy begins to fully open, policy conditions will shift to fighting inflation and the yield curve will reverse quickly …


That is when the 2-year/10-year spread will give you a warning and an advantage on shifting to a more bearish stance on equities.


The S&P 500 will have hit 4,500 before that happens, but I always want to introduce more tools that can keep us Income Hunters ahead of the game.


In the meantime …


Live and Trade With Passion My Friends,


Griff

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