As Rates Rise, Financials Can Shine

It has been a bumpy 2022 so far for the financials sector, and value stocks more broadly. As a major part of the value indexes, the sector’s performance can influence how the style performs. With the US Federal Reserve (Fed) raising interest rates again, the environment for both financials and value may be turning more favorable, in our view. After a lengthy period of historically low interest rates, rising rates can help boost earnings for financial companies, particularly for those that lend or invest their premiums in fixed income. Banks are also seeing a sharp pickup in loan demand, further supporting more positive industry fundamentals, and creating new opportunities in both the United States and Europe. The longer the war in Ukraine rages and energy prices remain high, however, the greater the potential for a sharp deceleration in global economic growth, which may abruptly end this tightening cycle.

Lower for (Not Much) Longer

It seems like a lifetime ago that 30-year fixed rate mortgages were above 15% and money market yields were measured in actual, whole percentage points. Financial stocks across the developed world have been coping with a historically low interest-rate environment for over a decade. In response to the 2008 financial crisis, global central banks slashed interest rates. It was only when the recovery was well underway in late 2015 that the Fed began raising rates again, ending the tightening cycle in 2018.

The pandemic forced central banks to slash rates and restart the quantitative easing measures first rolled out during the financial crisis. As a result, some financial companies have seen their profitability suffer, dragging down stock prices. Near-zero interest rates in the United States and negative rates in Europe have compressed net interest income (NII), or the difference between the income banks generate from their lending and their funding costs, like the interest rates they pay out on deposits.