At the start of last semester's course on Bank & Treasury Management (BSF222), I told students that I would gladly buy them (individually!) a cup of coffee at Via Café if, by the end of the course, the stock price of JP Morgan [NYSE: JPM] was higher (lower) and the yield curve flatter (steeper) compared to the levels seen the first day of class. I should have been more prudent, as I was caught off-guard by the initial euphoria on bank stocks after November 4. Yes, the yield curve became steeper —which justified higher valuations— but other factors were contributing to the surge in the stock, such as the expectation of lighter regulation ahead, a possible end to the annual stress-tests, and even a rumored withdrawal from the BIS and its pesky capital adequacy rules.
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The yield curve, as measured by the yield difference between 10- and 2-year notes, peaked at 1.31% in mid-December, sharply up from its pre-election level of 0.99%. It then began to flatten, surely but slowly, as the Fed thightened while inflation expectations were being kept in check. JPM, however, continued to surge, closing at $93.30 on March 1. By that time, I would surely lose my bet —as I did in the end. (No student, however, has claimed his/her right to a cup of coffee). But see how things have changed in just a couple of weeks! With the yield curve down again (now at 92 bps), JPM closed yesterday at $82.15, a 12.6% decline from its intraday high of $93.98.
An investor could make a living by trading the stock of JPMorgan off the changes in the shape of the yield curve. The sheer size of its balance (north of $2.5 trillion) makes it naturally sensitive to changes in interest rates. Could we build a model for that?
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