Banks have gotten off to a great start in 2021, with most major bank indexes up significantly since the beginning of the year. The sector has benefited from two large stimulus bills and positive reopening and vaccine news. But the biggest boost has been the increase in longer-term bond yields as shorter-term rates have remained near zero — otherwise known as a steepening of the yield curve.
That helps banks because they typically like to borrow money short term and lend it out long, so a steepening curve can increase their profit margins on loans and securities. And longer-term rates may continue to rise this year, while shorter-term rates also may increase sooner than expected, although almost certainly not this year. This positions large banks quite well. Here’s why.
A major source of revenue for banks is net interest income (NII), which is the difference between the interest income they make on loans and what they pay out to fund the loans. Both interest income and interest expense are tied to the Federal Reserve’s federal funds rate, which impacts most shorter- and long-term rates.