The year 2022 could bring some of the biggest interest rate rises in history. As the reference rate rises, interest rates on loans and credit cards rise evenly. It seems that the banks providing these loans should be the biggest beneficiaries of this situation. Is this the moment to invest in this sector?
The situation of borrowers in the United States
Currently, the volume of all consumer loans in the United States has increased by 17% y-o-y. and has climbed to historic peaks, amounting to as much as USD 934 billion.
According to Lendingtree, the number of people with a personal loan increased from 19.9 million in 2021 to 20.4 million in 2022. Personal loans accounted for 2.8% of the total debt of US citizens. The country's economic problems may be translating into interest in this form of debt. The average balance of a new personal loan was US$6,656 in the first quarter of 2022, compared to US$5,155 a year ago.
According to Lendingtreel, almost 6 in 10 borrowers (57.6%) opted for a personal loan to consolidate debt or refinance credit cards. The next most common reason was home renovation (5.8%). Currently, the average interest rate on credit cards is 16.27%, the highest in more than 20 years. This compares with an interest rate of 13.59% before the financial crisis in 2008.
However, the situation for borrowers currently appears favourable. The percentage of personal loans in default (over 60 days) stands at 2.08 and is one of the lowest in over 30 years. During the crisis in 2008, this percentage even reached 6.77%. It could be concluded that despite the rising cost of debt, it seems that there is no threat of insolvency for the banking sector for the time being.
How did the banking sector behave during the rate hike cycle?
There have been four cycles of interest rate rises in the past 25 years. These began in the years: 1999, 2004, 2015, 2022 (the current one). During them, interest rates were raised by successively: 1.75 percentage points (in 12 months), 4.25 percentage points (in 25 months), 2.25 percentage points (in 36 months) and 4.5 percentage points (currently in 9 months).
Source: Conotoxia MT5, US500, Daily
During these rate rises, the Financial Select Sector SPDR Fund (XLF), which mimics the behaviour of the US banking sector, achieved the following cumulative returns (including dividends): 28.4%, 38.33%, 57.5%, -8% (current). During this time, the cumulative performance of recent rate hike cycles has outperformed the S&P 500 Index (US500). However, it should be noted that the banking sector is largely a dividend sector and the performance of the sector excluding dividends would be worse than the market average.
During periods of falling interest rates, the fund achieved the following returns: -7.72% (2000), -60.24% (2007), -29.17% (2020), compared to the S&P 500 Index, for which the rates were respectively: -24.11%, -40.02%, -14.1%. This shows that the sector appears to be performing particularly poorly during periods of interest rate easing.
Source: Conotoxia MT5, XLF, Daily
Looking at the data presented by the FedWatch tool, which collects analyses of future interest rate forecasts, we could possibly see the peak of interest rate rises in March 2023, and may expect the first reductions in September next year.
Grzegorz Dróżdż, Junior Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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