Idea of the Day Europes banking renaissance

What: All hail the breakout of the German 2-year bond yield to a fresh high for 2017 at a whopping -0.634%. This has helped the German yield curve to steepen substantially as you can see in chart 1, and it is now at its highest level since November. A steeper yield curve is a sign of economic confidence in the currency bloc, and it can also help to boost banks’ profitability.

How: We think that rising Eurozone (read German) bond yields will be good news for Europe’s banking sector as it should boost their profitability over the longer term. However, some of Europe’s banks have internal troubles that could weigh on their share price. We decided to do a quick analysis of Europe’s main banks and found that Spain’s Santander is the outperformer compared to Deutsche Bank and Societe General, as you can see in figure 2.

A basket of long European banks could pay off in an environment of improving profitability for Europe’s banking sector, otherwise the relative performance of Santander, Societe General and Deutsche Bank is worth investigating. If you think that Deutsche Bank shares, which have underperformed their peers in Europe’s banking sector, could benefit in the longer term, then an options trade may the best thing for you. A long call position with a duration of 2-3 months is worth considering. If you get an out of the money strike price, say above this year’s high so far at EUR 18 -20, then this could reduce the overall cost of the option, and the most that you can lose is the premium that you pay upfront. This is one way of limiting your downside while also hoping to benefit from a bounce back in Deutsche Bank’s share price if it starts to react to the improvement in German bond yields.

Chart 1: 

Source: City Index and Bloomberg 

Source: City Index and Bloomberg