The esoteric economic concept of the yield curve is "becoming more mainstream for investors" in the banking sector, analysts at Keefe, Bruyette and Woods believe, as they tipped Barclays PLC (LSE:BARC) as one of their top picks in Europe.
KBW said a steepening yield curve is likely to support net interest income (NII) upgrades across the sector, with Irish and Italian banks also among the most rate-sensitive names.
For the uninitiated, the yield curve shows the difference between short- and long-term interest rates, with a steeper curve typically signalling improving profit margins for banks, which tend to borrow short-term and lend long.
Analyst Andrew Stimpson at the broker argued that consensus is overstating the NII headwinds by relying on a “parallel down” rate sensitivity framework, which assumes that interest rates across all maturities fall by the same amount, without changes to the shape of the yield curve - and does not account for the benefit of rising long-term rates.
He said the impact of falling short-term rates is about one-third less severe than assumed in current forecasts, while a steeper curve would be more supportive still.
The KBW analyst said net interest margins (NIMs) – the difference between interest rates charged for loans and paid on interest – are expected to beat expectations, particularly where the sharpest falls are already priced in.
Stimpson highlighted that Irish and Italian banks, for example, have seen their rate sensitivity halved in the short-rates-only scenario. Ireland's AIB Group PLC (LSE:AIBG) is another of KBW's top picks in the European banking sector, along with Italy's ISP, Belgium's KBC and France's Societe Generale.
The broker described the current market environment as "very rare", containing ongoing EPS upgrades, 10-year yields above 2.5%, and long-end rates more than 30 basis points above 3-month levels.
"The one obvious blemish on the bull case for the sector is the threat of reciprocal tariffs," the analyst wrote. "We shall know more on April 2, but it's also possible that this will not be the end of the saga here.
"The EU has delayed its own counter-measures until mid-April to allow extra time for negotiations.
"For banks there is very little direct effect, but the wider concern would be on what it means for bank customers."