The US Federal Reserve have signalled that they will be pursuing a tighter monetary policy, which translates to an increase in interest rates. Retail investors looking to understand the banking sector should take note of this: this usually translates to good news for banking stocks.

Rising rates tend to point to a strengthening economy. This means that borrowers have an easier time making loan payments, which in turn means that banks have fewer non-performing assets. Banks can also earn more from the spread between what they pay (to holders of savings accounts and deposit certificates) and what they can earn (from debt instruments such as U.S. Treasury Bonds).

However, there can be caveats to this since rates aren’t the only determinants to banks’ fortunes. In this follow-up article to our our prior coverage on banking ETPs, we’ll examine the scenario as it stands for the banks underlying some of our ETPs – HSBC (ticker: HSBC), Barclays (ticker: BCS), J.P. Morgan (ticker: JPM), Citi (ticker: C) and Goldman Sachs (ticker: GS).

Financial Sector: Pain Ahead

2021 started with a bang when it came to financial stocks. Large stimulus packages and vaccine availability were considered important reasons for this optimism. In addition, the Federal Reserve signalled two rate hikes in 2023. Since increasing interest rates typically help improve profit margins of banks, this should have been additional factor for upticks in this sector.

Despite all of this, by the end of Q2 2021, the S&P Financial Sector Index (IXM) had a large tumble immediately after a record 11% increase since the start of the year. Historically, there has been a strong correlation between IXM and its parent index the S&P 500 (SPX). This relationship came unglued in 2021.

The reason for this is the fact that banks don’t just derive revenues from interest rates. They also generate a significant amount of their revenue from non-interest bearing activities: brokerage services, banking-related service charges, credit card-related fees, mortgage-related activities, etc. These activities are heavily dependent on economic factors that the market doesn’t consider being very optimistic at the moment.

As of 17th of June, IXM’s performance has dipped below that of the SPX.