Why the Fed could derail the hottest trade since the election

Banks have been on a tear, but one portfolio manager warns the very thing that propped them up could soon take them down.

Financials is the best performing sector since the election, surging more than 30 percent and hovering near a 10-year high. Chad Morganlander of Washington Crossing Advisors says the banks could soon face one obstacle that prevents them from rallying even further.

"Going forward in the next 6 to 9 months, we do believe there will be negative headwinds, like a flattening of the yield curve as the Federal Reserve starts to raise interest rates," said Morganlander. "And we believe that they'll raise interest rates 3 to 4 times for the next 12 to 18 months."

Commercial banks make money off the difference between what they pay for short-term deposits and what they earn by making long-term loans. As the difference between the short- and long-term rates narrow, banks' ability to make money suffers.

Kathy Lien of BK Asset Management agreed that a flattening yield curve may eventually be a headwind for financials, but said a combination of overall rising interest rates, tax reform and deregulation could continue to push the space to new highs in the near-to-intermediate term.

"Obviously stocks are doing well, there's a strong risk appetite there, [plus] tax reform and the lax regulatory environment that could come is really conducive to further gains in the financials," she said Friday on CNBC's "Power Lunch."

"So I think that combined with the prospect of further yield increases and interest rate hikes could fuel further gains in the financials," she added.

"I think we have a little bit more room to go," she said. "Obviously we're at 10-year highs, which could be a headwind [and also] the Fed chair pick could dampen yields depending on who's selected. But I think in the long run we may actually see some more new highs in this index before we actually see any type of meaningful correction."

The financial sector is trading roughly 14 percent below its all-time high, hit in May 2007.

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Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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