Markman Capital Insight

Why robust labor data means big profits for banks

The April Job Opening and Labor Turnover Survey continue to add support to the idea the weak March payroll report was an anomaly and that the job market is rapidly moving towards full employment.

The quit rate rose to 2%, suggesting the balance of power in the labor market is finally shifting from employers to employees. This also suggests wages, a powerful contributor to overall inflation, are about to get a big lift. It’s about time.

The bond market is already pricing all this in, which is the most important thing to know right now.

According to Capital Economics, the lift in long-term interest rates in late April was initially driven by a rise in inflation expectations, no doubt connected to the rebound in crude oil from a low of $42.41 a barrel in March to the $60 a barrel now -- a searing advance of more than 40%.

Now, the rise in long-term interest rates (and thus, the price weakness of long-term Treasury bonds) is being driven by a big increase in economic growth expectations driven in large part by the assumption that empowered consumers are on the cusp of providing a big boost to retail sales and the housing market over the summer. Consumers have been a finicky bunch lately however, and there is no guarantee they are finally going to break out their credit cards and buy stuff.

Elsewhere wild cards remain in focus. In Europe, negotiations with Greece -- which eked out its IMF bond payment today -- are dragging on like a bad movie with subtitles. It feels like Ingmar Bergman is directing this one. Moreover, Eurozone stocks sold off as core Euro bond yields keep drifting higher in a reversal of the "Euro QE" trade.

Here at home, Fed officials all seem to be stressing the data dependency of their rate liftoff decision and the fact that the June 17 policy announcement is "live" for a potential rate hike. San Francisco Fed President John Williams admitted Tuesday that the unemployment rate is nearing its natural rate, that it would be safer for the Fed to start raising rates earlier, and the Fed's ability to delay rate hikes is more limited now.

The smart money in the futures market are calling their bluff: The going assumption is that no action will be taken until September, at the earliest, with rising odds of no action until early 2016.

The silver lining in all this is that the widening gap between low Fed-controlled short-term interest rates and rising market-controlled long-term interest rates is a potential boon to bank profits via increasing net interest margins. This is the difference between the "cost" of funds via short-term deposit rates vs. the "revenue" of long-term loan rates.

No wonder the KBW Regional Banking SPDR (KRE) moved to test highs from early last year -- threatening a breakout of a tight consolidation range going back to early 2013. Stocks like Keycorp (KEY) and US Bancorp (USB) will be worth keeping an eye on for possible entry points in the days to come.

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