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Bleak outlook for European i-bank revenues amid late-cycle, geopolitical woes

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Bleak outlook for European i-bank revenues amid late-cycle, geopolitical woes

European investment banks should brace for another rocky 12 months. The year 2019 is shaping up to be dominated by uncertainty and volatility amid investor worries about the maturing credit cycle and global geopolitical tensions.

Last year was marked by several spikes in market volatility that prompted equities sell-offs and surges in bond yields. The sell-offs worsened in the fourth quarter, with some of the steepest drops registered in December. The VIX volatility index surged 160% across 2018 while the MSCI World index closed the year down by 11%,"its worst annual performance since the financial crisis," Berenberg equity analysts said in an EU mid-cap report published Jan. 7.

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Dutch bank ABN Amro said in a Jan. 8 report that investor risk sentiment has deteriorated amid worries about a global economic slowdown, less central bank liquidity and trade wars.

Against this backdrop, European investment banks are set to encounter more challenges in fixed-income, currencies and commodities trading in 2019 after a difficult 2018.

Positive trends skewed toward US

Barclays PLC and UBS Group AG were the only two out of eight major European investment banks tracked by S&P Global Market Intelligence to book growing FICC revenues for the first nine months of 2018. Credit and rates were the main underperforming products that pulled down fixed-income revenues for most banks. Commodities achieved continuous growth throughout the period on the back of recovering energy markets, but U.S. banks benefited the most from that positive trend.

European investment banks are still playing catch-up with their American counterparts, auditing firm Deloitte said in its 2019 Banking and Capital Markets Outlook. For the first time since 2012, global investment banks are set to book revenue growth in both their trading and advisory businesses but a "recovery in fortunes" has been skewed toward U.S. banks, it said. They continue to dominate the sector and occupy the top spots in M&A, equity and fixed-income underwriting, Deloitte added.

Furthermore, top European players such as Deutsche Bank AG and Credit Suisse Group AG are still restructuring their trading arms, which is likely to delay revenue recovery there.

Overall, the FICC cost base at trading units of global investment banks remains high and should be brought down further, Deloitte noted.

"[A]lthough some progress has been made in rationalizing expenses, the job is not complete," the firm said.

Equities were the main driver of revenue growth at most European investment banks, with five out of eight institutions in the S&P Global Market Intelligence sample reporting rising revenues for the first nine months of 2018.

Sustained volatility

Global trade tensions, a tightening of monetary policy and ongoing uncertainty around Brexit are among the key risks that could rattle European markets, according to market observers.

A last-minute resolution of Italy's budget conflict with the European Union removed another big downside risk to bond markets as EU authorities accepted the Italian government's new budget deficit goal of 2% in 2019, reduced from the initial 2.4%. Italian bonds rallied after the deal was struck Dec. 19, 2018, and started 2019 trading positively with yields retracting to their lowest level since early September 2018.

But the uncertainty around Britain's departure from the EU remains a major headwind. A no-deal Brexit, which would see the U.K. crashing out of the EU without any arrangements past the March 29 deadline, would make investors more cautious, reduce client activity and in turn hit bank trading revenues.

"All is looking very chaotic and [it] is hard to make any reasonable projection what is going to happen," Octavio Marenzi, CEO of investment firm Opimas, said in an interview. Markets might be entering a period of "increased and sustained volatility," he said, but added this will not be bad for all market participants.

Some international investors may find opportunities in the U.K. as asset values drop given the weakened British pound, Pictet Asset Management said in its market outlook.

Central bank moves

The gradual turn in the monetary policy of global central banks is an even bigger concern, according to Marenzi. Markets are spooked by the prospect of increasing interest rates, he said.

Over the past decade, central banks have been keeping a lid on market volatility by cutting interest rates to historic lows and providing additional economic stimulus through quantitative easing.

The U.S. Federal Reserve is ahead of the European Central Bank on its way to policy normalization, having hiked interest rates several times in 2018 and planning more for 2019. Thus, "the risk of a monetary policy error is rising" as the Fed may tighten policy too soon increase the probability of recession, Rabobank Research said in a Dec. 10, 2018, market outlook.

The "danger zone" for a U.S. recession will be reached in 2020, according to U.S. brokerage firm Russell Investments, which expects the Fed to make three to four interest rates hikes in 2019.

The ECB may follow suit soon, as it has now ended its asset-purchasing QE program. Analysts expect a first interest rate hike in late 2019. The end of QE will hit European debt markets in particular but equities will not be spared either.

The exact end of the credit cycle and the ensuing sell-off is "nearly impossible to predict," according to Andrew Jackson, head of fixed income at Hermes Investment Management.

"This leaves us facing an investment universe with more obvious opportunities, but potentially more frequent pitfalls," Jackson said in a market commentary.

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