The Financial Select Sector SPDR Fund (XLF) has shown surprising strength recently, driven by impressive earnings reports from major banks like JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC) and Citigroup Inc. (C).
Despite heightened market volatility tied to escalating trade war tensions, bank stocks and the ETFs that hold them have managed to outperform the S&P 500 in the first quarter of 2025—thanks largely to a surge in investor trading activity.
Fueled by tariff threats and fears of slower global growth, uncertainty in the markets has led to increased trading volume across asset classes, boosting banks’ revenue from their trading desks and capital markets divisions.
JPMorgan, for example, reported a strong uptick in equity and fixed-income trading revenues, while Citigroup and Bank of America also posted better-than-expected results from their trading operations.
Investors navigating choppy markets tend to rotate more frequently across sectors and asset classes, creating fertile ground for trading-related profits. This has given big banks an edge during an otherwise mixed earnings season.
Rising short-term interest rates and a relatively steep yield curve have also helped support the big banks’ net interest income, further fueling profitability.
The financial giants may continue to profit from trading activity and the current rate environment, but uncertainty over tariffs continues to cloud the 2025 outlook.
Despite recent strength, bank stocks and broader financial sector ETFs like XLF face mounting risks if current trade disputes escalate and push the U.S. economy into a recession later in 2025. A deepening trade war could dampen business and consumer confidence, reduce global trade flows and ultimately weaken credit demand—all of which would weigh heavily on bank profitability. Loan growth, a key earnings driver for banks, could slow significantly if businesses pull back on investment and consumers cut spending.
Recessionary conditions may also trigger a rise in loan delinquencies and defaults, particularly in sectors sensitive to economic downturns, such as commercial real estate, consumer credit and small business lending. This would force banks to increase loan loss provisions, directly cutting into profits. Lower interest rates—likely if the Federal Reserve shifts to an accommodative stance in response to weakening economic data—could further pressure banks’ net interest margins, which have already come under scrutiny in past downturns.
Financials are also highly cyclical by nature, making them more vulnerable than defensive sectors during periods of economic contraction. In such an environment, investor sentiment toward financial ETFs like XLF could turn negative, leading to underperformance relative to the broader market. While trading revenue has been a bright spot, it’s not enough to offset the structural challenges banks face in a downturn, making the sector increasingly vulnerable should macroeconomic risks intensify.
