Ratings firm Moody’s downgraded its outlook for global investment banks (GIB) Tuesday from “positive” to “stable” citing the slowdown in growth, and lower or negative interest rates.
According to Moody’s, these GIBs — which includes the likes of Goldman Sachs, J.P. Morgan, HSBC and Deutsche Bank — will see their profitability come under greater pressure over the next 12 to 18 months. They will also witness low client activity due to global uncertainties, Moody’s said.
“The stable outlook for the global investment banks reflects our expectations that profitability for the GIBs may have peaked for this economic cycle,” Ana Arsov, managing director at Moody’s, said in the research.
Many central banks around the world have performed U-turns with their monetary policy, cutting interest rates in order to boost lending in their economies. Lower interest rates, however, restrict a bank’s ability to make profits. Rising rates, meanwhile, are good for banks as they allow them to lend money to investors with a profitable rate of interest.
The research states that slow economic growth and high levels of corporate debt could lead to higher costs for investment banks. And although accommodative policies from a central bank could support financial conditions, the risk of a sharper slowdown has risen, particularly with escalating trade and geopolitical tensions, Moody’s said.
Investors around the world are worried about the escalating trade war between the U.S. and China. President Donald Trump said following the Group of Seven (G-7) summit in Biarritz, France on Monday that China was sincere about a trade deal with the U.S., though his claim that Chinese representatives called top U.S. trade negotiators on Sunday night to resume talks has been disputed by Beijing.
The tentative signs of rapprochement come following announcements of tariff escalations from both sides in the trade war.
Inverted yield curve
Investors have also been focused on a critical spread between the 10-year and two-year U.S. Treasury yield, which has inverted several times over recent weeks. It is widely seen as an indication of an impending recession and, according to Moody’s, is another risk for banks.
“This is prompting much hand-wringing because the recessions that began in 1980, 1982, 1990, 2000 and 2007 were all preceded by an inversion of the yield curve,” Russ Mould, the investment director at AJ Bell, said in a research note.
“The prospect of a recession is a worry for those investors exposed to so-called ‘risk assets’ like equities and commodities as it will hit their earnings power and demand for them respectively, to the possible detriment of their valuations and prices.”
An inverted yield curve occurs when long-term bonds have a lower yield compared to shorter-term bonds. When this happens, businesses can find it more expensive to expand operations.
Meanwhile, consumer borrowing could also fall, thus leading to less spending in the economy. All of these could mean a subsequent contraction in the economy and a rise in unemployment.