Persistent Low Interest Rates Bring Bank Woes

June 21, 2016Economic Conditionsby EW News Desk Team

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Persistently low interest rates are set to hit bank profits in America, triggering warnings from analysts across Wall Street.  A number of notes released late last week and early this week to clients warned that Federal Reserve policy is likely to hinder bank profits for a long time, bringing to doubt both Wall Street’s ability to improve profitability and the future of employment in the financial sector.

Over the last two years, investment banks have shed hundreds of thousands of jobs both in America and abroad, as low and negative interest rates hurt profitability and increased regulation limited investment opportunities for large banks.

Swiss bank UBS was one of the highest profile firms to discharge employees, with over 20,000 jobs lost in one fell swoop last year. Additionally, Deutsche Bank and Citibank have also cut jobs and lowered foreign operations.

European Harbinger

The decline in bond rates in Europe caused bank profitability to decline in that region, as banks failed to earn a sufficient profit from the spread between short-term and long-term bond rates.

The decline in bond rates has befuddled many analysts, who expected the European Central Bank’s (ECB’s) historically unprecedented quantitative easing program to cause bond yields to rise. In 2013, the Federal Reserve’s bond buying program caused yields to rise, with the 10-year Treasury exceeding 3% at its highest point at the turn of 2014.

The ECB has so far failed to replicate the Fed’s success in raising bond yields, with several theories being posed about why the event has been able to be replicated. Some analysts argue that demographics remain a headwind to the ECB, while others noted that the steep decline in oil prices caused broad-based deflationary pressures that the ECB cannot fight.

As a result, bond yields continued to fall throughout the QE program, reaching negative rates for short-term and long-term issues in Germany and an increasing number of other countries in the Eurozone. Some analysts warn that the EU’s unified currency, coupled with distinct fiscal policies in the region and a too-rigid restriction on the bond-buying program, have made QE a failure in Europe.

American Focus

Now analysts are worried that negative yields might come to America, bringing down bank profitability as a result. Citing the Federal Open Market Committee’s decision to halt an interest rate hike in June, and growing hints that a rate hike might happen much later in 2016 or not at all in the year, has led to worries that bond rates will continue to fall. The 10-year Treasury fell near its record low, at less than 1.6%.

A growing number of analysts are recommending to investors that they buy Treasuries and short bank stocks in an aggressive, high-risk, pair trade that will capitalize on declining yields and the eventual negative interest rate policy that is likely to come to America in the next few years.