U.S. Treasury bonds "fall," Wall Street major banks "are well-fed"

Recently, long-term U.S. Treasury yields have soared, which has frightened investors, but it may actually be good news for banks.

Why do banks like a steepening yield curve?

A steepening yield curve simply means that long-term interest rates are rising faster than short-term rates. For example, the yield on 10-year U.S. Treasuries is much higher than that on 2-year Treasuries, which is referred to as an expanding spread. Recently, the spread between 2-year and 10-year U.S. Treasuries has reached its highest level since 2022.

This is very important for banks, because their profit model is to borrow short and lend long.

Their funding sources are short-term, such as deposits from savers at very low interest rates, and the returns on these deposits are mostly linked to short-term rates. Then, banks lend money to others for the long term, such as mortgages, auto loans, and corporate loans, which have higher interest rates. Alternatively, banks may invest in long-term assets, such as mortgage-backed securities or long-term U.S. Treasuries.

Therefore, low short-term rates and high long-term rates equal earning a spread, also known as net interest margin. The steeper the yield curve, the larger this spread becomes, and the more money banks make.

In recent years, the U.S. Treasury yield curve has been very flat or even inverted (where short-term rates are higher than long-term rates), which has made it difficult for banks to earn money.

Now, if the curve normalizes again, net interest margins are expected to improve, alleviating pressure on banks and improving the operating environment. Even if the short-term economy faces uncertainties due to trade wars, inflation, and worsening fiscal deficits, as long as the curve is steep, banks' core businesses may actually improve.

After years of low net interest margins, is the opportunity finally here?

For the past few years, net interest margins have been relatively low. According to a report by TD Cowen, as of the fourth quarter of last year, the median net interest margin for large U.S. banks was 2.81%, below the historical average of 3.2%. Analysts believe that as interest rates return to normal and the yield curve slopes positively, net interest margins are expected to improve.

Moreover, as long-term rates rise, the new bonds purchased by banks will yield higher returns, and when older low-rate bonds mature, the cash can be rolled into new high-rate bonds. This allows banks to continuously increase interest income, and these profits can bolster the banks' capital buffers (which are their risk-bearing funds).

If the Trump administration also relaxes capital regulation requirements for banks, the available funds for banks will be even more ample, enhancing their resilience.

However, rising long-term rates pose potential risks for banks, as the prices of bonds purchased at low rates in the past have fallen, increasing unrealized losses on their books.

If banks urgently need cash to meet depositor withdrawals, they may have to sell bonds at a loss, leading to the kind of collapse risk seen with Silicon Valley Bank in 2023. At that time, Silicon Valley Bank held a large amount of low-rate long-term bonds, and the Federal Reserve's aggressive rate hikes caused the value of those bonds to plummet. Once depositors began to withdraw en masse, the bank had no choice but to sell bonds at a loss, resulting in losses and liquidity exhaustion, ultimately leading to its failure.

Therefore, rising long-term rates are a double-edged sword; they can enhance banks' interest income and asset returns, but they can also amplify unrealized losses and potentially trigger liquidity risks during a crisis.

Earlier this year, U.S. bank stocks briefly outperformed the market as investors bet on a soft landing for the economy and increased lending. However, by March and April, as tariff concerns intensified and recession risks rose, bank stocks turned around and underperformedAs of now, the KBW Nasdaq Bank Index and the S&P 500 Index have almost the same year-to-date increase, indicating that the market is still hesitant. Analysts point out that if the yield curve continues to steepen moderately and the logic of net interest margin recovery holds, the banking sector may welcome a new round of upward momentum.

For bank stocks, if economic growth occurs, banks can allocate more funds to issue loans, earning more interest as the economy improves. If loan demand is not strong, banks can choose to use excess funds to repurchase shares