Last Wednesday, The Board of the US Federal Reserve cut the Fed Funds target rate by 25 basis points in the face of the continued threats to global growth they see on the horizon. Thanks to sluggish growth in Europe and an escalating trade war dispute between the US and China, traders and investors expect another cut at the September meeting and Fed Funds futures at the CME currently imply a 65% chance of a 25 basis point cut and a 35% chance of a 50 basis point reduction.
In general, interest rate cuts are a positive development for businesses because they reduce the cost of borrowing and make capital investments less expensive, but there’s one specific class of business that suffers when rates are low – financial lending institutions.
London-based Barclays PLC (BCS) is one such institution that is finding the current interest rate climate difficult.
The most recent management commentary on Barclays financial results contains numerous references to the “challenging” environment.
While the short-term rates in the US are at historically low levels, they remain in positive territory, while European Central bank rates are effectively zero, and longer-term debt markets in Europe aren’t much higher. Thanks to a massive undertaking of quantitative easing, European government bond yields remain well below their US equivalents.
Low rates decimate profits at lending institutions because they reduce the spread between borrowing and lending rates to uncomfortably low levels.
During 2019, Barclays shares have badly lagged the performance of the foreign banks sub-industry and the S&P 500, falling 6% versus gains of 3% and more than 15%, respectively.
Quite admirably, Barclays management has focused on cost cutting and operational efficiency and in the long term, those moves might pay off, but it’s not a plan for growth in the near future. They’re basically treading water. 3,000 layoffs were recently announced this past Spring, even after management vowed that no jobs would be lost.
Certainly, you can’t fault a nimble management team or taking aggressive steps to ensure survival in the worst possible conditions, but jobs cut don’t tend to be an indication of growth prospects. Recent global events make it likely that rates will stay low for the foreseeable future.
Earnings estimates for Barclays have been falling lately, earning the beleaguered bank a Zacks rank #5 (Strong Sell).
Even worse than falling earnings estimates for banks are low marks in Return on Equity, Return on Assets and Return on Capitol and Barclays trail the industry average in each category.
Investors looking for opportunities in the Banking Sector would be better served looking at US regional banks OFG Bancorp (OFG) or Hilltop Holdings (HTH) , both Zacks Rank #1s (Strong Buy).
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