Regional Banks Gaining on Fed's Possible Hawkish Change on Rates

NEW YORK (TheStreet) -- Interest in regional banks is rising as speculators push up long-term interest rates ahead of next week's Federal Reserve meeting.

Investors have pushed up the exchange-traded fund representing regional banks, the iShares Dow Jones US Regional Banks (IAT) , by nearly 6% since early August while selling the iShares Barclays 20+ Year Treasury Bond (TLT)  ETF because they think the Fed may raise benchmark interest rates before next summer.

The regional bank ETF is most heavily weighted by U.S. Bancorp (USB) , PNC Financial Services  (PNC) , BB&T (BBT) , SunTrust Banks (STI)   and Fifth Third Bancorp (FITB) .

IAT Chart
IAT data by YCharts

The relationship between regional banks and rising long-term rates is simple: regional banks largely make their money from paying interest on short-term deposits while turning around and investing in longer-term bonds. As the bond market drives Treasury yields higher, banks put that same money in Treasuries and get a greater return.

So regional banks will make larger profits simply by capturing the increased spread between short-term and long-term rates.

Although the Fed is not expected to raise interest rates before it completely winds down its bond-purchasing program, analysts are looking for clues at next week's meeting that could possibly signal a tighter policy stance.

One of the most debated topics is whether the Fed will drop the phrase that says there will be a "considerable time" from the end of the Fed's bond purchases to the first rate hike.

"Considerable time" has generally been interpreted to mean at least six months. If quantitative easing is set to end in October, that would peg next summer as the most likely time for the first rate hike from the Fed in eight years.

But dropping the phrase from next week's statement could signal rates may be increased before next summer, and that would lead to a broad selloff in Treasury bonds.

Because of the uncertainty, such interest rate-sensitive assets as SPDR Barclays High Yield Bond (JNK) and iShares Core Total US Bond Market ETF (AGG)  are being sold off now. 

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

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This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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