These stocks could surge on a Fed rate hike

Trading Nation: Financial rally ahead?

Many bank investors are looking forward to a Federal Reserve rate rise, as this could impact the Treasury environment in such a way as to make the lending business more profitable. But some banks are liable to be helped much more than others.

The Fed is widely expected to raise short-term interest rates this year. This could increase long-run inflation expectations, leading to an eventual steeping of the yield curve (meaning that long-term rates will rise in relation to short-term rates). As borrowing in the short term to lend for the long term becomes more profitable, bank earnings are expected to rise.

However, Larry McDonald, head of macro strategy at Societe General, says banks won't be affected equally.

Traders work on the floor of the New York Stock Exchange.
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Looking back at the 2013 "taper tantrum," when the yield curve widened considerably on sudden fears about the end of the Fed's quantitative easing program, McDonald found that small bank stocks rose 24 percent, while large bank stocks rose just 13 percent.

"A steepening yield curve is extremely positive for banks, but it's much better for the small banks," McDonald said, perhaps because lending is a bigger part of the small banks' business.

To be sure, the precise way that the yield curve will react to the expected Fed tightening, as well as the ways that specific bank stocks will respond to the new environment, remains to be seen.

So far this year, the ETF containing large financial stocks (XLF) is down 2 percent, while the regional bank ETF (KRE) is up by nearly 2 percent.

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