While some European bank stocks have scrambled back some of their plunge losses post-Brexit, the current uncertainty over when the U.K. will start the process of quitting the EU has banks on tenterhooks, with a source telling CNBC that banks are "preparing for an economic nuclear winter situation." With negative rates (and a plunging yield curve) banks' earnings are under threat but the concerns over the potential for contagious European break-up and collapse of the pound after Article 50 is signed is existential.
Another dead cat bounce in EU banks?
Speaking on the condition of anonymity due to the sensitive nature of the topic, a source from a major investment bank told CNBC that financial services firms have put together a strategy in place that takes into account the worst-case scenario that could happen by the end of this year.
"This could mean triggering Article 50, referendum in other European nations leading to a break-up of the euro or sterling hitting below $1.20 or lower. The banks are ready for anything now," the source said.
The source further explained that the challenge in 2016 is nothing compared to when the Lehman Brothers collapsed in 2008 and the banking sector is this time a lot more resilient. "Markets hate uncertainty and the events this year have unfortunately created a lot of mystery around what is going to happen next."
Meanwhile, a common theme across second-quarter results has been a warning of uncertain times ahead. From big investment banks to mining firms like BHP Billiton and Glencore to the auto sector, companies have cited uncertainty and volatility in markets as a reason for weak results and have warned that the second half will be challenging.
But we note that EU banks relative performance to broad EU stocks remains glued to the yield curve… (not level of rates)
As we noted previously, at negative rates, banks’ business model becomes unsustainable. If rates are negative for long enough, the business faces a life threat.
Other factors (Fintech, over-regulation, etc..) are second order drivers, though all headwinds at present times.
In truth, the business models of pension plans, insurance companies, money managers are all affected by what happens to the yield curve, in different ways. But nobody like a Bank is so inescapably impacted by its shape.
At times, good Banks can skilfully outperform their core commodity – the yield curve – and smoothen its widest gyrations across the cycle. Like a good oil company can diversify and smoothen the violent swings of oil prices.
But can they totally disconnect from it? Unlikely.
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