Margin pressure for the banks

US earnings are again causing a push-pull scenario in the US session. IBM reported a terrible set of numbers which was offset by United Tech and Verizon.

Source: Bloomberg

The US earnings season stats are more or less unchanged from Monday’s set of numbers, however top line growth is actually slipping further into the red. Will this be the first quarter in the last 27 that US corporates fail to beat estimates on the top line? 

Rate debate is getting louder with the interbank market now pricing in a 21.7% chance of a 25 basis point cut on Melbourne Cup Day, from 39% on Monday.

The Reserve Bank of Australia (RBA) minutes were, as expected, very neutral. In fact, I would go as far as to say ‘positive’. Certainly not hawkish, but the minutes highlighted the economic positives that are currently being seen in the Australian economy. The RBA points to the positives in the consumer and business surveys as a key bright spot. Q3 is expected to report increased consumption, housing investment and  key exports of tourism and resources (thanks to the AUD), as well as expected increases in service exports.

The view of the RBA goes very much against the views of over 17 economists surveyed by Bloomberg in its RBA rates survey. I can’t find a single reason in the minutes from October that would suggest there will be rate cut on 3 November. Will the RBA be caught out or will the 63% of the surveyed economist be found wanting? I know what I’m backing.

The RBA has put the AUD in a bind, commodities are sliding after one of their best combined weeks in 2015 at the start of October which should naturally see the AUD sliding. However, the central bank divergence trade is breaking down; the Fed’s expected December hike is evaporating with every new piece of US data. An RBA cut in 2015 (on the current information on hand) is not a likely event with each piece of RBA communication seen. The call to see 66 to 68 cents for the AUD is more likely to be a 2016 event rather than a 2015 event.

The RBA also puts the banks in focus. Margins and return on equity (ROE) have been the key talking point for the banks since Westpac’s decision to raise its home rates out of cycle.

Return on equity (ROE) is under pressure from the new macro-prudential laws. The increased capital on balance sheets will dilute ROE. With the banks’ ex-growth  priced at a premium from a share market perspective, the Westpac move is somewhat understandable, as it will lift ROE. The second part of the bank’s argument is margins. Net interest margins (NIM) have been declining consistently as the cash rate has been cut and the loan price war has ramped up (also feeding back into ROE).

The catch from the margin side is the deposit taking. If you look at UK and Canada’s record low cash rates periods, private deposit rates have shown very high levels of stickiness around the 2% rate. Although cash rates were close to zero in either country, UK and Canadian banks were unable to drop term deposits (TD) below 2% for several years, as investors still demanded total return and would withdraw funds if offered rates under this level.

Australia is facing the very same issue, as TDs below inflation will force deposit holders elsewhere. This will increase the banks’ dependence on wholesale funds, which squeezes NIM even further. This is why I suspect the banks will move as one and raise lending rates to positively impact their NIM.

The question will be whether the RBA eases the new rules (which Westpac is blaming for its decision) or cash rates to counter the private banks tightening. 

The markets are still very quiet, and we’re calling the ASX down 17 points to 5218. However, BHP’s ADR is pointing higher up 0.3% to $24.07. It’s a tricky trading period as there is no clear pattern in the current market.

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