By Jim Donnelly, Olson Global Markets

After having formed a bullish reverse Head & Shoulders pattern (by breaking above “neckline” resistance at 47) on daily bar charts, the Keefe, Bruyette & Woods U.S. Bank Index (BKX) reversed lower and has just retested its neckline, this time as support. The key question now is whether its “neckline” will continue to act as support and fend off sellers, or give way to them instead.

If, in fact, this neckline can hold as support, resumption to an upward bias would likely occur, eventually targeting a test of the 78.50 area. That would, of course, represent a healthy increase percentage-wise from Friday’s closing levels and would likely improve overall market sentiment dramatically.

If, on the other hand, the 47 area fails to act as support, a break in the recovery spirit and drearier investor psychology could well emerge.

In the intermediate-term, larger banks may now face narrower margins as they conform to the newly passed financial reform bill. In addition, a flattening yield curve will likely restrict the banks’ ability to recapitalize itself over the near-term. Further, these banks’ credit card operations will likely reduce top line revenues because of their inability to accurately price their products to “risk”. Instead, the recently crafted credit card reform legislation will likely reduce margins and dampen credit extension to consumers.

Nevertheless, extraordinarily low interest rates should have a positive impact on asset values, helping to reduce provisions for loan losses. In addition, qualified borrows will clearly benefit from depressed interest levels helping them to grow their businesses.

In either event, the direction of the BKX should become resolved sometime soon with the 47 level squarely in focus.

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