U.S. president-elect Donald Trump’s promise to cut taxes and boost government spending has driven up long-term interest rates and led to an unexpected comeback in the U.S. banking sector, with banks’ share prices rising at a rate not seen since the boom before the financial crisis.
This newfound optimism has spread to Europe. Analysts at JP Morgan are recommending shares in European banks with a low valuation and a high financial surplus, such as DNB in Norway, ING in the Netherlands and Lloyds in Britain. They expect French bank Société Générale and Spain’s Santander to achieve growth in earnings per share, and also favor Swiss bank Credit Suisse and French bank Natixis, as a relatively large proportion of their business comes from the United States.
Even shares in German banks, which sustained harsh losses a few months ago, are in demand again. Shares in the market leader Deutsche Bank have gained more than 50 percent since the beginning of October, having plunged to a record low in September amid speculation regarding a possible state bailout.
The prospect of a rise in interest rates has played a large part in this. The core business of banks in Germany in particular has suffered for too long due to extremely low long-term interest rates, which have led to job cuts and massive cost-cutting programs in the sector.
Since being elected, Mr. Trump has surrounded himself with hedge fund managers as advisors and has recruited two former Goldman Sachs bankers as advisors. The days when the U.S. government treated banks as the enemy and punished them with fines running into billions appear to be over, or at least that is the hope in the sector. The days of economic paralysis, with sluggish growth and too-low interest rates and inflation, also seem to be over.
An important banking index calculated by investment banking firm Keefe, Bruyette & Woods (KBW) that maps global development in the industry has soared from around 780 points to over 900 points since the U.S. presidential election. This trend is likely to accelerate in view of the latest interest rate hike by the U.S. central bank, the Federal Reserve, which will be positive for banking business. The Fed raised its base rate this week and has announced a further three increases for next year.
Higher long-term interest rates help banks as their traditional business involves collecting money in the short term and lending it in the longer term. The associated increase in the risk of inflation doesn’t worry banks; only savers live in the real world, where the inflation rate must be deducted from interest earned, while banks live in the nominal world and inflation does not occur on their balance sheets.
The rise in interest rates goes hand in hand with an increase in yields on long-term U.S. and German government bonds. This was initially driven by rising oil prices, which stoked expectations of higher inflation, and has been further boosted by Mr. Trump’s promises of tax cuts and an infrastructure program. The yield on 10-year U.S. government bonds has climbed 1.3 percentage points to almost 2.6 percent from a low in early July and now stands at its highest level since more than two years. The yield on 10-year German government bonds has recovered from a historic low of minus 0.2 percent in July to 0.3 percent, according to the most recent figures.
The situation is different for short-term German bonds, however, as the European Central Bank is expected to keep its base rate at zero for a long time to come, while the deposit rate is actually minus 0.4 percent. “That will also keep bond yields in the euro zone very low at the short end,” said Martin Lück, a senior capital markets strategist at fund company Blackrock. The yield on two-year German government bonds has sunk to a historic low of minus 0.78 percent.
“Even if the interest rate environment is starting to improve, this isn’t likely to be strongly reflected in the institutions’ profits for the time being.”
The rally in German banking shares could still face several obstacles. Helmut Hipper, a fund manager at Union Investment, warned: “Even if the interest rate environment is starting to improve, this isn’t likely to be strongly reflected in the institutions’ profits for the time being.” Kroll Bond Rating Agency points out that the rise in bond yields will be associated with falling bond prices and corresponding write-downs.
The crucial question, however, is whether Mr. Trump actually keeps his promises. He will have to get his tax and spending plans through parliament, and analysts at KBW warn that Democrats in the Senate will fiercely oppose the relaxation of regulations for banks. They therefore warn against overestimating this effect.
The question also remains of whether “Trumponomics” will boost the U.S. economy as hoped. This will become a fateful question for banks and the investors betting on them. Investors are ignoring the long-term rise in government debt that will result from increased state spending, and already appear to have forgotten the fact that economists described Mr. Trump’s economic plans as completely unrealistic before the election. No one wants to interrupt the party that Mr. Trump has started on the stock markets, particularly among banking shares. Experts at JP Morgan have warned of greater volatility in banking stocks.
Michael Brächer covers investment for Handelsblatt. Frank Wiebe, who covers finance for Handelsblatt, is based in New York. Andrea Cünnen works at Handelsblatt’s finance desk in Frankfurt, reporting on the bond markets. To contact the authors: firstname.lastname@example.org, email@example.com, firstname.lastname@example.org