Trump tariffs and the banking sector reaction

President Trump announced global widespread tariffs, with only LatAm, Australia and the UK being relatively spared. This was widely expected, and the announcement had been marketed as “Liberation Day“ weeks in advance. So, the “new news” was actually about two things, we believe:

• The tariff formula was so unorthodox (effectively tariffs proportional to trade deficit in %) that the market realised this was not based on economic substance, but purely on a goal to eliminate the US trade deficit. This implies that the announcements are just the beginning of what could be a long period of retaliation, counterretaliation, etc.

• The market estimate for weighted average tariffs was around 15%, vs. 18.3% announced, and the number for China and Vietnam (which has had a massive increase in trade with the US after Trump’s first administration Chinese tariffs) was strikingly high.

The market reaction was sanguine: sharp drop in the yield of government bonds (Bund futures up +1.42%), in global equity indices (Stoxx 50 –6.57%, European banks -12.24%), in HY bond markets (AT1 approximately 2%) and rise in credit spreads (Main 5Y +19bps, Crossover 5Y +53bps).

Thursday, the spread to benchmark of the AT1 Bloomberg index was up +100bps compared to the lows (mid-February) and all YTD spread tightening had been erased.

Focusing on European financials only, we would stress the following:

• Both AT1s and equity had a strong run YTD. AT1 spreads were on the low-end of historical standards. This was largely due to better fundamentals (rating upgrades, improved profitability, stable capital ratios, low NPL and cost of risk) but creates incentives to take profits for the short-term minded investors.

• On AT1 bonds, and subordinated financial debt in general, the carry has been strong enough to protect performance. Spreads on AT1 bonds are now above 350 bps.

More importantly, the macro shock created by Trump has two main impacts for banks: a changed outlook on rates and an increased recession risk. 

The general consensus is that tariffs will create a one-off inflationary shock that central banks will ignore and a recession shock leading to lower rates.

• One risk European banks are facing is the return to the zero-rate (or even NIRP) policy of the ECB. 

  • Banks we are talking to share the same general view: as long as ECB rates stay above the 1.75% - 2% area, they expect net income to be stable or even increase. Markets are now pricing 3 cuts by March 2026, vs. 2.5 a couple of days ago. 

  • This is significant, but also still within the sweet spot for bank earnings. Not so long ago, the market was debating how much the German fiscal plan (1tn€) and corresponding supply would push German rates higher and if this would force the ECB to pause rate cuts…

• The beta of European banks’ daily outperformance (vs general market) compared to a German 2033 bond has been around -69% over the past couple of years. The shock of the past couple of days has been off the chart (beta of around 5).  Naturally, banks’ sensitivities to rates are variable and some are better positioned than others to navigate the shape of the curve.

• The recession risk could impact bank earnings via additional NPL and provisions. But the situation is not so dire:

  • The starting point is good: cost of risk is low, banks still have a very large amount of management overlays (precautionary provisions introduced by IFRS 9) and most banks are on a favourable credit rating path.

  • The most important variable in bank provisioning is not GDP, but unemployment, which is still on a downwards trend, largely due to secular demographics trends.

  • On the corporate / SME side, the risk is naturally skewed towards the exporting sectors and banks we talk to that have exposures to “exporting countries” (Italy, Germany…) see pockets of risk in auto, machinery, chemicals, metals and construction. But these sectors have been already facing structural headwinds, which means the books are already provisioned with overlays and the companies are already embarked in cost cutting programs. In our view, the risk will be focused on a handful of banks with sector-specific SME lending expertise in exporting countries but will not be significant for the credit profile of the global sector.

  • Under a two-year, zero-growth scenario for the EU we think the aggregate cost of risk of the sector would grow around +15bps/+20bps above current consensus values. This is significant but not enough to jeopardise the current very generous distribution policies (sector total yield above 10%) due to the high excess capital – and AT1 distributions even less so.

• Bank with EM exposure have been “lucky” to see rather benign tariffs news for LatAm. BBVA is even optimistic about the impact of tariffs in Mexico as they believe the interconnectedness of Mexico and the US mean that tariffs would have to be applied several times, which is so costly that offshoring to Mexico would probably increase, not decrease! The situation of HSBC (which is also facing significant CRE risk in Hong-Kong) and Standard Chartered, the so-called “Asian European banks” is probably more challenging on that front, but they are very strong banks from a credit profile point of view.

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