Regional-bank stocks experienced a lag in the broader market on Friday, but managed to recover from earlier lows as Wall Street responded to an increase in Treasury yields. The rise was driven by a stronger-than-expected September jobs report.

Impact of Uncertainty and Yields

The dual impact of uncertainty surrounding a potential interest rate hike by the Federal Reserve and an increase in yields, resulting in declining bond prices, had a more significant effect on mid-sized and smaller banks.

Market Performance

The SPDR S&P Regional Banking ETF (KRE) saw a 0.4% decline, while the S&P 500 (SPX) rose by 0.5% after initially falling earlier in the day. The Dow Jones Industrial Average (DJIA) also saw an increase of 0.6%. The KBW Nasdaq Bank Index (BKX) rose by 0.3%.

Weekly Performance

For the week, the SPDR Regional Banking ETF has declined by 2.2%, the KBW Nasdaq Bank Index has fallen by 3.4%, and the S&P 500 has dropped 0.5%.

Individual Issues

KeyCorp (KEY) fell by 0.7%, Fifth Third Bancorp (FITB) decreased by 1.5%, and U.S. Bancorp (USB) dropped by 0.3% on Friday.

Meanwhile, the Financial Select Sector SPDR ETF (XLF), which includes the largest banks, rose by 0.7%. It is currently down approximately 0.9% for the week.

JPMorgan Chase & Co. (JPM) saw an increase of 1.3%, Bank of America Corp. (BAC) rose by 0.8%, and Goldman Sachs Group Inc. (GS) increased by 0.9% on Friday.

Impact of Treasury Yields

Sharp increases in Treasury yields have pushed the 30-year rate intermittently past 5%, marking the highest level since August of 2007.

See: Spiking long yields are a danger for markets: here’s what may happen next and 5 things investors should do

Higher bond yields directly affect the fair value of bank bond portfolios, while also leading to higher unrealized losses on the bank's loan portfolio. Additionally, these factors put pressure on deposit costs and present a headwind on net interest income.

Regional-bank performance is particularly vulnerable due to their lack of diversification seen in larger banks, making it challenging for them to balance out their results.

Bond Yields and Banking Sector Challenges

Richard Bove, an analyst at Odeon Capital, recently highlighted the impact of increasing bond yields on the banking sector. According to Bove, these higher yields have intensified problems faced by banks. The decrease in bank assets value and equity value, as a result of the higher yields, intensifies the need for the Treasury to inject more equity into the banks. Additionally, it poses challenges for banks in increasing deposit rates.

The yield on the 2-year Treasury dropped from earlier levels but still ended with a gain of 4.4 basis points, reaching 5.067% on Friday compared to 5.023% the previous day. Similarly, the yield on the 10-year Treasury rose by almost 13 basis points to 4.842% from 4.715% on Thursday.

The monthly jobs report from the U.S. Department of Labor revealed that the U.S. economy generated 336,000 new jobs in September, surpassing Wall Street's expectations of 170,000 new jobs. This positive labor-market outcome has increased the likelihood of further interest rate hikes by the Federal Reserve as they aim to manage inflation and stabilize the economy.

Earnings season for banks is set to begin on October 13 with updates from JPMorgan Chase, Wells Fargo & Co., and Citigroup. The industry will be closely watching these reports to gain insights into upcoming bank performance and the overall state of the economy.

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