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Another Sign Interest Rates Are on the Rise

By Chris Lowe, Editor-at-Large on June 15, 2015

Another sign that interest rates are on their way up is investors’ renewed interest in the banking sector.

Banks tend to do well as interest rates rise for two reasons.

Read more > Why central banks want a zero interest rate world

First, rising interest rates usually signal a stronger economy.

A stronger economy typically increases demand for loans – banks primary source of profits. It also makes it more likely that borrowers will have the funds to repay their loans. This keeps a lid on dreaded non-performing loans (liabilities for banks).

Second, rising rates tend to increase banks’ profit margins. That’s because the “spread,” or gap, between the interest they pay you or me on a deposit – and the yield they can earn by investing those deposits in the bond market – widens.

The chart below tracks the performance of the financial sector relative to the S&P 500. When the line below is falling, it means the financial sector is underperforming. When it’s rising, it means the financial sector is outperforming.

061515-DRE-Financial-Selector-SPX

At the start of this year, financials were one of the worst-performing sectors in the S&P 500.

But as the economy has picked up, expectations of an interest rate rise from the Fed have picked up along with it… and the financial sector has become one of the best-performing S&P 500 sectors.

At least some investors are starting to price in the end of near-zero interest rates.

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