Financial stocks are sliding as the bond market's short end prices in more Fed rate hikes, with the Financial Select Sector SPDR Fund (XLF) now almost 6% off its highs. A flattening Treasury yield curve threatens bank profitability, and according to Mott Capital Management founder Michael Kramer, the sector's slide could weigh on the broader market.
Yield curve flattens sharply
The Financial Select Sector SPDR Fund (XLF) fell 1.97% as the 2-year Treasury yield climbed faster than the 10-year, flattening the yield curve amid expectations of a further Fed rate hike. The 10-year to 2-year spread has narrowed to just 21 basis points, compared with more than 70 basis points before the U.S.-Iran war started.
That matters because higher rates could slow loan growth and raise banks' funding costs, while a flatter curve could pressure net interest income — the spread between what banks earn on loans and pay out on deposits. If banks pull back on lending as a result, companies could have less capital to grow and consumers could find it harder to borrow.
Financials lag as S&P 500 nears record highs
While the S&P 500 pushes toward record highs, the XLF trails behind. The fund is almost 6% off its own highs. The decline began on Sept. 4, the day markets received a strong August jobs report that pushed the bond market to take a Fed rate hike seriously.
According to Michael Kramer, founder of Mott Capital Management: "the XLF ETF has traded closely with changes in the yield curve" over the past three years and beyond. The 5-year to 2-year spread has narrowed to just 9 basis points, raising the odds of a curve inversion.
Technical levels point lower
The XLF recently found support near $55, a level tied to a technical gap from July 2 and the 100-day moving average. However, the ETF has broken through an uptrend formed off its March 2026 lows and faces resistance at the 10-day moving average. If the yield curve flattens further, Kramer says the ETF and sector could fall toward their next major support level near $53.25, which coincides with the 200-day moving average.
Financials need the yield curve to stop flattening, or an economic-data break that causes the Fed to back off further hikes. But with the hiking cycle still in its early innings and inflation showing no signs of easing, that prospect appears limited for now.
Source: MarketWatch
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