What a Week: Banks Take a Beating

Another week of tame losses for major averages obscured the harsher fall of financials as a few key economic developments sent interest rates skyward. The lesson that banks can prosper even when rates rise was all but ignored.

For the week, The Philadelphia Stock Exchange/KBW Bank index lost 3.4%, and it's now down 4.5% for the year. That was considerably worse than the 0.1% drop in the Dow Jones Industrial Average, to 10,784.78, or the 0.3% decline in the S&P 500, which ended at 1201.6. The Nasdaq Composite lost 0.9% on the week to 2058.62.

The simple reason why the financial sector got hit is that the yield on the 10-year Treasury note rose from under 4% just over a week ago to 4.26% at the close on Friday. The big hits have come from signs that the economy is doing well, that the Fed plans to keep raising rates and that higher inflation might be brewing.

Lower-than-expected weekly jobless claims for the past two weeks took bonds down along with stronger-than-expected regional Fed surveys of activity.

In addition, Federal Reserve Chairman Alan Greenspan testified before Congress on Wednesday and Thursday that the economy was doing well and the benchmark fed funds rate was still "fairly low." That wasn't quite what the legions who were expecting that the Fed would soon put its campaign of measured interest rate hikes on hold wanted to hear.

The capper came Friday, as the core producer price index showed a 0.8% rise in January, the biggest one-month jump since 1998. Lower oil prices in January, which already have reversed this month, helped bring the headline number down 0.3% for the month.

Handling the Vagaries

While a higher 10-year rate will raise the rate on home mortgages, hurting banks that rely on refinancings for the bulk of profits, most banks are considerably less specialized. And loans to commercial and industrial borrowers are just now picking up steam. Unlike most mortgage loans, most commercial loans carry a variable rate of interest, protecting the bank -- not the borrower -- when short-term yields rise.