Europe's banks depend on German interest rates

Chart of the week

A look at the correlation between Eurozone bank stocks and Bund yields shows historically how much banks have been dependent on long-term interest rates. The reasons for this are revealing.

You may not want to be a bank analyst these days. Large, mostly globally positioned, complex institutions with diverse business areas and models. Besides that, there are always new regulations and young financial-technology companies pressuring already tight margins. This is certainly no fun. But it is even less fun if you don't just have to analyze this sector, but have been invested in it. In mid-August, the sector was valued on Europe's stock exchangesat its lowest level since 1989.[1]

But what to do, if you still want to invest in this sector, perhaps for anti-cyclical reasons? After all, in addition to the long-term price being low, a price-to-book ratio of only 0.6 is tempting – if you take the reported accounting figures at face value. At first glance, one way of escaping the complexity of the sector seems to be a striking correlation. As our "Chart of the Week" shows, the performance of the banking sector relative to the overall market is almost parallel to that of 10-year German government bonds (Bunds). The correlation coefficient, based on the weekly performance over the past ten years, is an astonishing 0.91.

It is probably the combination of two reasons that can explain this synchronicity: On the one hand, long-term interest rates are seen as an indicator of how investors assess growth prospects. As a highly cyclical sector, banks are thus predestined to benefit from brightening economic sentiment. Secondly, there is the interest margin, on which European banks depend much more than their U.S. counterparts, where corporate loans hardly play a role any more. Since the short end of the yield curve, in particular the European Central Bank's (ECB's) refinancing rate, has been close to or at zero for some time, the margin depends largely on the interest-rate level at the long end of the curve. So investing made easy? Unfortunately only from an ex-post perspective again. Ex-ante you have to have a clear opinion of how 10-year interest rates may develop. Anyone who also believes that interest rates will remain low for some time, will probably have to look elsewhere for returns.  

20190920_CotW_Banks and Bunds_CHART_EN_72dpi.png

*Relative performance of the Euro Stoxx Banks Index over the Euro Stoxx Index

Sources: Refinitiv, DWS Investment GmbH as of 9/17/19

1. Measured by the Euro Stoxx Banks, which comprises the banks in the Eurozone

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