US banks have been on a tear since the US election, buoyed by expectations of increased fiscal stimulus on the one hand and hopes of looser regulation on the other. Over recent months, however, the big US banks have begun to underperform.
Despite three US interest rate rises since December and the Federal Reserve´s (Fed) forecast to raise interest rates one more time this year, US Treasury yields have actually been edging down of late.
Volatility across capital markets has also been more subdued, posing a headache for the trading businesses of big US investment banks.
Ultra-low interest rates and quantitative easing have been a thorn in the side for both US and European banks alike since the financial crisis. The resulting low-yield environment naturally puts a squeeze on what banks can charge borrowers, hampering overall profitability.
Donald Trump´s win in the US presidential election and his pledge to boost growth through tax cuts and spending was seen as a turning point for the sector. There were also hopes that the new administration would soften the regulatory environment for banks.
While the Fed had already been contemplating hiking interest rates prior to the US election, Trump´s win raised expectations on future US interest rate rises as the market factored in higher US economic growth due to fiscal stimulus.
Over recent months, however, investors have had to contend with weaker US economic data. First-quarter US economic growth slowed considerably compared with the prior quarter (1.2% versus 2.1%).
Of late, US retail and manufacturing gauges have also weakened while inflation has surprised on the downside.
US 10-year Treasury yields rose from 1.8% prior to the presidential election to reach 2.6% by early March. Weak US economic data has since seen yields in the same US Treasury segment decline to around 2.3%.
It´s been a similar story for US banks, with the sector having rallied 24% since the US election, outperforming the US equity market as measured by the S&P 500, which has returned 16% since November 8.
Since early March, however, it´s been an entirely different story with the US banks down by 3.5% versus a positive 4.6% return for large-cap US equities in general.
Against this backdrop, US banks have been reducing their earnings forecasts.
For the second quarter of 2017, Citigroup, JP Morgan Chase and Bank of America all reported a decline in net interest margins, which measures the difference between what banks can earn from lending and what they must pay for borrowing themselves.
It’s a cautionary tale for investors in European banks as well. Even when the European Central Bank (ECB) begins to catch up with the Fed and eventually starts raising interest rates, there may be a long road ahead before we see a tangible pick up in European banks' profitability.