Impact of European Monetary Policy on Bank Margins in the US
European monetary policy matters to bank net interest margins in the US because the risk of disinflation has collapsed European bond yields (to 1.6% on the 10-year from 2.2% at end-2013) dragging down US Treasury yields (to 2.6% on the 10-year from 3%). US fundamentals, including likely 2.5%+ GDP growth over the next 12-months and improving labor markets, are consistent with mid-cycle recovery and higher rates, and this is reflected in the forward markets.
The rate cuts and liquidity measures announced by the ECB today, along with aggressive remarks from Mr. Draghi’s (“Are we finished? The answer is no”), will reduce the disinflation premium in Eurozone, and hence US, bonds by increasing confidence in the downwardly-revised ECB forecast for 2014 growth in GDP of 1%. The ECB added that, should inflation (forecast at 0.7% for 2015 vs. the policy target of near 2%) not respond to today’s measures, it would shift to quantitative easing.
Of course, US bank margins are affected by interbank, rather than Treasury, rates and specifically by the 3-year swap (3YS) rate given the average duration of bank balance sheets. The forward markets are pricing in a 3YS rate of 2.6% for mid-2015, up 20 basis points in the last week and vs. 0.9% today. With 6-month Libor (6ML) indicated at 1.6% vs. 0.3% today, bank margins will likely have a meaningful tailwind from both rising rates and a steeper curve.
- As shown in the Exhibit below, our model suggests a margin-benefit in 2015 vs. 2014 of 80 basis points (50 from increased slope and 30 from the impact of higher short rates on the return from liability, and specifically, deposit franchises).
Some rate-benefit will be seen in bank margins in 2014 but offset by pricing pressures on loans. Since 2012Q4, for example, the increase in slope (3YS less 6ML) has added 60 basis points to bank margins but been overwhelmed by a 70 basis point decline in asset spreads; as a result, the overall margin aggregated across US commercial banks has declined to 3.1% from 3.3%. That said, bankers are now reporting a stabilization of loan pricing, and we expect rate benefits to begin to flow through to reported margins this quarter and beyond.