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Regional Banks Fall as Long-Term Treasury Bonds Surge Over Ukraine, Fed

NEW YORK (TheStreet) -- Shares in regional banks, whose profits are heavily affected by falling interest rates, have been battered these days. As geopolitical tensions in the Ukraine triggered a flight to safety, investors moved toward longer-dated bonds.

Regional banks, such as  U.S. Bancorp (USB - Get Report), PNC Financial Services (PNC - Get Report), BB&T (BBT - Get Report), SunTrust Banks (STI), Fifth Third Bancorp (FITB), M&T Bank (MTB), Regions Financial (RF) and KeyCorp (KEY), are weighted the most in the iShares Dow Jones US Regional Banks Index (IAT). The index, which ended at 35.11 on July 3, was trading Friday at 33.68.

The iShares Barclays 20+ Year Treasury Bond Index (TLT), which reflects prices of bonds with maturities more than 20 years, rose as investors were moving on the longer part of the yield curve to offset the impact of the tapering by the Federal Reserve. Bond prices move inversely to yields. 

Diplomatic tensions spurred by the civil war in the Ukraine have also supported purchases of U.S. Treasury bonds, which are seen as a safe investment. Following reports that a Malaysian airliner crashed in eastern Ukraine on Thursday, iShares Barclays 20+ Year Treasury Bond Index spiked above 114, and will likely end the week above that level for the first time since May 2013. The plane crash and death of nearly 300 passengers and crew members have added to the ongoing tensions and make investors even more cautious.

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Yields on short-term Treasury notes, such as iShares Barclays 1-3 Year Treasury Bond (SHY),  have been pressured upward, ever since the Federal Reserve Chairwoman Janet Yellen said earlier this week that rates could rise sooner-than-anticipated, if the labor market continues to improve. The rotation out of short-dated Treasury notes into longer-dated Treasury bonds should continue to pressure long-term interest yields down.

Shares in regional banks are adversely affected by lower long-term yields, because their profits fall when rates decline. "Largely these banks make their money from three areas: fees for services, loans and certificate of deposits," Jim Cramer said in an article last year. The larger impact is via certificate of deposits as banks profit from the spread between CD and Treasurys -- the higher the latter, the larger the profits. As the bond market drives Treasury yields down, banks capture a smaller spread between CD rates and Treasury rates, leading to less profit.

Looking at the graphic below, which shows both the iShares Barclays 20+ Year Treasury Bond and the iShares Dow Jones US Regional Banks Index, it is clear how the two indexes have a negative correlation and tend to make large moves in the opposite direction. As long-dated Treasury bonds break to new yearly highs this week, the iShares regional bank index is developing a double-top bearish formation under 35.

If global geopolitical tension increases and long-dated Treasuries continue to move higher, expect the regional bank index to break below 32, and subsequently begin a downtrend throughout the remainder of the year.

TLT Chart
TLT data by YCharts 

At the time of publication, the author had no position in any of the funds mentioned.

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This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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