Sorry European Banks, The Recovery Will Have to Wait

Authored by Michael Msika and Jan-Patrick Barnert, Bloomberg macro commentators.

The glass is definitely half-empty for investors this week.

S&P 500 futures tumbled yet again overnight, which means Wall Street is set to extend Tuesday’s meltdown, and Europe will probably not escape the renewed sell-off.

With all the pessimism around and a number of macro indicators in Europe pointing to an economic slowdown, it’s worth having another look at one of the region’s biggest, and lately, largely unloved sectors: banks. European lenders can’t seem to wake up from a prolonged period of latency.

Just as the Stoxx 600 Banks Index attempted to cross this year’s dominating downtrend on Monday, the shares dropped back immediately. The sector remains among the weakest in Europe with a 23 percent drop this year -- the biggest annual slump since 2011 --outpaced only by autos.

Seized by a potpourri of pressure from Italian politics and spreads to Brexit and company-specific issues like money-laundering, there’s one thing that lenders, especially euro-area banks, are desperately waiting for: rate hikes.

Unfortunately, they may need even more patience, Fitch said Wednesday.  All eyes and hopes are on the European Central Bank to at least start some small rate hikes next year, a prospect that rating agency Fitch has now given-up on.

“Downgrades to the euro-zone growth outlook and stubbornly low core inflation now look likely to persuade the ECB to hold off from raising interest rates until 2020,” Fitch said.

That also doesn’t read well for the euro, which has helped set the pace for banks this year. With the ratings agency scrapping its call for rate hikes next year, things look even tougher for the remaining banking bulls.

And there aren’t many left: Investors’ exposure to financials was trimmed further in October and is now underweight, according to Barclays citing EPFR data. "Almost 40% of funds are now overweight financials, which is a 16% reduction from the January highs," the bank said. That’s also the median exposure over an 11-year period. There’s little doubt the picture didn’t grow rosier in November.

Fitch echoes some Commerzbank analysts who last week moved their estimate for the first ECB hike into the first quarter of 2020 as they expect inflation to stay low. While this might not shock bank shareholders, with much rate-hike skepticism was already priced in, it sure dampens the chance for any reasonable bottom-line improvement next year.

The unexpected slowdown in Italian GDP over the third quarter was another blow to a macro-sensitive sector. Italian banks already have difficulties to refinance themselves and can’t afford more steps in the wrong direction.

And yet, for many, it’s more of the same: More than 11 years since BNP Paribas froze funds that were exposed to U.S. subprime mortgages, which some consider as the starting point of the global financial crisis, banks have yet to recover.