Wall Street fixed income trading enters an early "winter," European banks expected to face pressure next

According to information from Zhihui Finance APP, the weakness in Wall Street banks' fixed income business in the third quarter does not bode well for European banks, as they are also dealing with rising interest rates.

Analyst Philip Richards commented: "I don't see any reason why the situation would be different for European banks. Rising interest rates, soaring uncertainty—the circumstances for American and European banks are entirely the same, and in fact, given the current situation in France, I think the European banking industry is worse off."

The market expects Societe Generale's fixed income and foreign exchange income to plunge by 10% in the third quarter, the largest drop among European investment banks. Deutsche Bank, BNP Paribas, and UBS will also report declines in fixed income income, with Barclays being the only exception.

Wall Street Fixed Income Trading the First to "Enter Winter"

This will echo the experiences of their American counterparts. U.S. banks’ fixed income trading income fell by an average of 5%, with Goldman Sachs (GS.US) mentioning a "notable decline in net income from mortgage and credit products." JPMorgan (JPM.US) saw its fixed income, foreign exchange, and commodities income drop year-over-year for the first time in over two years, and Morgan Stanley (MS.US) recorded its second worst quarterly performance in three years.

Data shows that Bank of America (BAC.US) saw its fixed income trading income drop 17% year-over-year in the third quarter, more than three times the average decline of its U.S. peers. Only Citigroup (C.US) achieved growth against the trend.

European Banks' Fixed Income Performance May Follow US Peers

Due to high interest rates suppressing bond issuance, bond trading divisions are facing an even tougher environment. In the US, uncertainty over the Federal Reserve’s next moves has also made some clients reluctant to take large positions. The rekindling of inflation concerns has further clouded the interest rate outlook.

French Risks Add Up, Bond Market Outlook Still Grim

As concerns over France’s fiscal situation intensify, volatility in the bond market is only likely to worsen. The French debt crisis has put several major French banks—Societe Generale, BNP Paribas, and Credit Agricole—under the spotlight, as they are the main holders of French government bonds.

Whereas American banks can rely on their equities business to offset the weakness in fixed income, European banks have a weaker capacity in this area. Banks such as Barclays and Societe Generale failed to replicate Wall Street’s strong second quarter equities trading, increasing the likelihood of broad-based weakness among European investment banks in the third quarter.

KBW analysts Thomas Hallett and Andrew Stimpson wrote in a report that UBS appears to be "relatively well positioned" due to its limited credit exposure and stronger focus on foreign exchange trading, which has become a bright spot in FICC business. Analyst Richards believes Barclays may perform well, but the room for a significant outperformance is small.

Barclays will release its financial report on October 22; UBS, Deutsche Bank, and BNP Paribas will report on October 28; Societe Generale will report on October 29.

Looking ahead, the outlook for the region’s largest lenders is turning gloomier, with the global bond sell-off reviving memories of the 2012 sovereign debt crisis, and persistently high oil prices heightening inflation concerns.

"Everywhere we look, there are risks: sovereign exposures, collapsing fiscal conditions across Europe," Richards said. "I certainly wouldn’t claim that distress in the fixed income market has bottomed out, because it looks like this distress might persist for some time yet."