Where to Hide from Higher Rates?

A traditional refuge for traders when interest rates are on the rise is bank stocks since they tend to have expanded margins. But the pending recession could warrant some caution.

Not all banks are the same

When central banks tighten, the drop in liquidity for the stock markets generates drag pretty much across the board. The one major exception is that banks' primary source of revenue is the difference in interest rates. Higher rates imply the possibility of charging a more extensive spread. And banks have been under pressure quite a bit over the last decade with perpetually low-interest rates.

Banks are better off when interest rates rise. But in the UK, the world's financial centre, some banks are more affected by external factors. On the other hand, not all banks have all their eggs in one basket, making it easier to weather specific shocks. However, right now, a weak pound is more likely to impact overseas income than not. But if it strengthens, it could give another advantage to international firms.

What to look out for

The BOE warns of a recession, which usually comes with a rise in non-performing loans. Banks have to make provisions for that, which could weigh on profitability. However, those provisions can turn into profits if the situation isn't as dire as expected.

Lloyds stands apart as it is a local UK bank with a relatively high dividend yield. Hence it is more attractive to investors, especially if the BOE keeps raising rates slowly for longer. Rivals Barclays and HSBC have a broader global presence, with the former having a significant investment banking arm. HSBC is also more exposed to the Chinese market, where the PBOC is looking to lower rates to stimulate the economy. The opposite of the situation benefits western-focused banks, such as Lloyds and Barclays.

Lloyds makes a comeback after inverse H&S

The stock price of Lloyds banking group has recently peaked at 50.00p for the first time since March. Although the initial reaction offered a pullback, Lloyds remains bullish above the 200 and 50-day averages of 46.50p and 44.80p. Failing to hold the base might bring prices to consolidation should 42.50p and 41.00p hold firm. But below there, the risk of a breakdown below the March 7 low at 38.00p increases as the inverse head-and-shoulders formation would get invalidated.

There is a high likelihood that the 200-day offers at least a bounce, if not a reversal. 51.00p becomes immediate resistance in that case, with 53.00p and 56.00p in focus above. Breaking past the 50.00p round level and maintaining it as support will play a critical role in Lloyds's
short- and long-term outlook.

Key takeaways

Banks are less vulnerable to the effects of a pending recession because of the increased spreads they can charge while interest rates rise and liquidity falls. However, some British banks will face various external factors, especially if the pound weakens. The BOE expects a recession, so investors might turn to Lloyds for dividend yields, especially if the central bank continues to hike slowly.