KBRA Financial Intelligence

Banks to Feel Impact of Yield Curve Re-Inversion and Emerging U.S. Growth Scare

Trump Administration Seeks Lower Long-Term Yields

The 10-year U.S. Treasury (UST) yield fell near 2025 lows last week, briefly slipping under 4.2%. A rapid decline in long-term rates has reversed the recent steepening of the yield curve, pushing the spread between rates on 10-year and 3-month Treasurys (T10Y3M) into negative territory, and reviving an inversion of the yield curve. This shift in long-term yields carries significant implications for banks, whose profitability—as measured by net interest margin (NIM)—relies on their ability to fund long-term lending using deposits acquired at short-term rates.

In early February, KBRA Financial Intelligence (KFI) noted that an aggressive steepening of the yield curve was likely to be a positive trend for banks—provided that credit conditions remained stable. However, KFI also highlighted that the buoyancy of long-term rates was becoming an issue for the federal government and its ballooning deficit. These two developments are increasingly at odds, as Treasury Secretary Scott Bessent has emphasized that his and President Trump’s focus is on achieving “lower rates,” specifically for the 10-year Treasury note.

The U.S. fiscal 2024 deficit expanded to $1.8 trillion, marking the third-largest annual shortfall in history and an 8.1% year-over-year (YoY) rise. This deficit is being supercharged by expenditures on mounting interest payments, which surged to a record $1.1 trillion in 2024. The U.S. debt structure is heavily front-loaded, meaning a significant portion of outstanding debt matures within a short time frame. T-bills (Treasury securities with maturities of one year or less) accounted for $6.2 trillion (or 22%) of total U.S. marketable debt at year-end 2024. That exceeds a target range of 15% to 20% previously laid out by the U.S. Treasury Borrowing Advisory Committee (TBAC).

Accruing a glut of issuance with short-term maturities has been costly, but if the Treasury had instead financed that debt with longer-term maturities, the increased supply of notes and bonds would have likely sent the yields on these securities even higher, leaving the U.S. on the hook for bloated coupon payments over the course of many years. As such, Secretary Bessent’s desire to reduce the 10-year yield appears to be part of a larger goal to reign in what he has referred to as the U.S.’s “spending problem” by rolling over T-bills at lower rates throughout 2025 and, eventually, refinancing them with longer-term maturities.

Markets React to Sudden Recession Fears

One of the primary factors that would typically depress long-term rates is a slowdown in economic growth. While both President Trump and Secretary Bessent have rejected the idea of an imminent recession, they have acknowledged that federal spending cuts and new trade tariffs may result in a period of economic “transition” or “detox.”

These statements did little to assuage concerns about the administration’s approach to fiscal policy and the strength of the economy, as a growth scare appears to have engulfed bond and equity markets throughout the month of March. In addition to the decline in Treasury yields, the KBW Nasdaq Bank Index (BKX), which tracks the share prices of 24 publicly traded banks, has fallen 14% since reaching a 2025 peak on February 18. The BKX decline has outpaced the S&P 500 Index, which was down just 8% throughout the same period.

The underperformance of financial stocks relative to broader equity indices could continue if NIMs are once again squeezed by a prolonged inversion of the yield curve. An inverted yield curve could suppress profitability and slow loan growth in the wake of deteriorating economic expansion. KFI data indicates that YoY growth in lending among U.S. commercial banks slowed significantly in 2022-23 but regained some ground in 2024 and stabilized at 2.2% in the final two quarters of the year.

Fed Likely to Remain on Pause for Months

While the administration is actively pursuing lower long-term rates, the Fed’s policy stance on short-term rates remains less clear. The Federal Open Market Committee (FOMC) is widely expected to continue their “pause” on rate cuts this week, but speculation is swirling about the trajectory of further easing later in the year. As of March 18, CME’s FedWatch indicated positioning in 30-day fed funds futures contracts implied just a 21% probability of the Fed’s next rate cut occurring in May. That is up from less than 15% one month ago, but still implies that a cut remains unlikely. The probability of at least one cut by June’s FOMC meeting is much greater at more than 64%, increasing significantly from about 45% on February 18. Based on those odds, short-term rates are expected by traders to remain anchored near their current levels for three more months, encompassing most of the second quarter.

Rate cut bets appear to have shifted forward in response to softer-than-expected employment and pricing data for February, but it remains unknown whether FOMC participants share the same dovish sentiment. Their most recent dot plot was released all the way back in December and projected just two cuts throughout 2025, but updated projection materials will be released for the first time this year on Wednesday. The Core Personal Consumption Expenditures (PCE) Price Index—the Fed’s preferred gauge of inflation—fell to 2.6% in January, tied for its lowest reading since 2021. The Fed has been attempting to guide the economy toward a “soft landing” for several years, which would require the central bank to successfully bring inflation down to its 2% target level “without causing unemployment to go up drastically and GDP growth to go negative.”

Much alarm has been raised in regard to the Atlanta Fed’s 1Q GDP nowcast flipping negative at the end of February, suggesting that economic growth may already be amid a quarterly contraction. Although not an official forecast of the Atlanta Fed, it is one of the four variables included in the economic projections of Federal Reserve Board members and bank presidents for every other FOMC meeting, implying that it may have some bearing on how Fed policymakers adjust their estimations of necessary easing in the months ahead. The Philadelphia Fed’s most recent Survey of Professional Forecasters paints a brighter portrait, with the median real GDP growth forecast at 2.5% for 1Q. The mean probability attached to negative growth throughout 2025 was roughly 5.5%.

These are critical considerations for banks, as they will not only be impacted by the prospect of declining growth but also the Fed’s response. If the Fed continues along the course outlined at the end of 2024, the persistence of yield curve inversion will likely remain a daunting challenge for margin expansion in the year ahead. By contrast, a shift among FOMC participants may give lenders a bit more breathing room to continue boosting NIMs if GDP growth holds up and borrowers remain creditworthy.

NIMs, loan volumes, and other key data for 10,000 individual U.S. banks and credit unions can be accessed via KFI’s web application, as well as the Data Wizard in KFI’s Excel add-in. To access our full library of tables and templates, request a demo today.