Momentum Builds Within the Banking Sector

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Since Brexit, UK banks have carved out a well-established and multi-legged up trend. With the sector rocketing higher this week let’s take a look and see if this rally is set to roll on…

Firstly, lets dispel the notion that what we are seeing is simply a ‘Brexit bounce’. The FTSE 350 Banking Sector Index recouped its Brexit losses in just over a month and has subsequently rallied over 20% past its pre-Brexit levels.

There are clearly other factors in play here.

Rising Rates = Rising Profit Margins

The first major driver behind the rally is increased expectations of rising rates – albeit namely in the US. Over this period US employment has steadily risen and inflation pressures have built. Accordingly, we are fast approaching the end of the current super dovish Fed era.

With higher interest rates supportive of banking profit margins the entering of a new interest rate cycle is of course welcomed by the sector.

Last month the sector again legged higher following Trump’s election win. The president-elect’s plans to boost US fiscal spending is widely anticipated to force the Fed into rate rises sooner rather than later. Some investors believe Trump will also cut banking sector ‘red tape’ but in truth the jury remains firmly out on that one.

Brexit Armageddon Fails to Materialise

Elsewhere, ‘armageddon’ style Brexit forecasts failing to materialise are also fuelling the rally.

Strong UK Q3 business investment and consumer spending has seen UK GDP growth beat forecasts. As investors become more comfortable with the idea that all is not doomed, investment has slowly starting rotating back into the highly cyclical financial sector.

Getting back to the here and now, this week we have seen the sector again kick back into gear. After rallying sharply higher Tuesday and Wednesday, the FTSE 350 Banking Sector Index is now at levels not seen since August 2015.

Despite momentum steadily building across the banking sector over the past five months, this latest leg higher needs to be heeded with caution.

Italian Worries – What Worries?

Into last Sunday’s Italian constitutional vote investor fears that a ‘no’ vote would severely hamper the ability for Monte dei Paschi to receive a bailout played heavily on the sector. Questionably, UK banks rallied sharply this week despite Italy’s constitutional vote failing and prime minister Matteo Renzi standing down.

Of course the bullish backdrop of rising rates and an improving UK economy still stand. However, with the capitalisation levels of Italian banks still looming and the sector looking over-stretched to the upside, we are heeding caution in the near term.

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