Profits for the world’s largest investment banks may come under pressure over the next 12 to 18 months, thanks to slowing global economic growth and the prospect of lower or negative interest rates. These trends led Moody’s Investors Service to downgrade its outlook for global investment banks (GIB), including Wall Street titans Goldman Sachs (GS), J.P Morgan Chase & Co. (JPM) and HSBC Holdings (HSBC), to from positive to stable. The ratings firm also expects client activity to decrease for these financial giants due to broader uncertainty in the market, per a detailed report by CNBC

Slowing Economic Growth, Falling Interest Rates

“The stable outlook for the global investment banks reflects our expectations that profitability for the GIBs may have peaked for this economic cycle,” wrote Ana Arsov, a managing director at Moody’s, in the recent report. "Greater revenue headwinds will make further profitability gains more elusive, despite a continued focus on business re-engineering and technology investments to boost efficiency,” he added. 

As central banks around the world have become more dovish in their economic policy, with many market watchers now expecting the Federal Reserve to cut interest rates again in September, the ability for banks to make a profit has decreased. While lower interest rates incentivize more lending, they also result in smaller margins for lenders. 

Moody’s expects global economic growth to slow this year and next, attributing a more negative outlook to escalating trade tensions and rising geopolitical uncertainty. This weekend saw rising trade tension between Washington and Beijing. On Friday, Trump sharply increased tariffs on billions of dollars of Chinese imports, prompting a retaliation. On Monday, the U.S president again shifted his tone. Following the Group of Seven (G-7) summit in France, President Trump said “China called last night,” and that the two countries will “very shortly” resume trade talks. Chinese officials said they were unaware of any recent telephone call. Most see the future of trade negotiations as largely up in the air. 

Unprecedented levels of corporate debt could also weigh on costs for investment banks. While accommodative policies from central banks could support financial conditions, Moody’s cites that the risk of a more severe slowdown has increased given the broader geopolitical landscape, per CNBC. 

Moody’s added that most countries in the G20 have “limited monetary and fiscal policy space for stimulating global aggregate demand.” 

Further weighing on revenues, in the 12 months ended August 22, fees generated by the investment banks fell by approximately 9% over the same period last year to $62.9 billion, per Deals Intelligence, cited by The National. Mergers and acquisitions activity, a major source of income for the GIBS, is also at risk.

What's Next

Another major red flag for banks is an inverted yield curve, viewed as an indicator of a forthcoming recession, per Moody’s. Over the recent weeks, market watchers have focused on the spread between the 10-year and two-year U.S. Treasury yield, which has inverted several times. This occurs when long-term bonds have a lower-yield and than shorter-term bonds. These conditions could lead to a drop off in consumer spending and company expansions, putting greater pressure on the economy and potentially leading to a larger contraction and spike in unemployment. 

“The prospect of a recession is a worry for those investors exposed to so-called ‘risk assets’ like equities and commodities as it will hit their earnings power and demand for them respectively, to the possible detriment of their valuations and prices,” wrote AJ Bell investment director Russ Mould, as cited by CNBC. He noted that the inverted yield curve is “promoting much hand-wringing” given it preceded the past five recessions.