ETF Trends
ETF Trends

The Financial Select Sector SPDR (NYSEArca: XLF) and rival financial services exchange traded funds have recently been gaining some momentum as markets price in increasing odds of the Federal Reserve boosting interest rates in the December.

Still, the the financial sector remains one of the worst performing areas of the S&P 500 of 2016. Financial services is the second-largest sector weight in the benchmark U.S. equity index.

Now, some market observers are concerned U.S. banks could be hampered by the lingering weakness in their European counterparts.

SEE MORE: Bank ETFs Could Shine in Q4

The iShares MSCI Europe Financials ETF (NYSEArca: EUFN) is one of this year’s worst-performing non-leveraged sector ETFs. Market observers have warned that the ongoing monetary polices and depressed rates would weigh on banks’ bottom line as firms would find it hard to make money with a flat yield curve – banks borrow short-term and lend long-term.

“Ultimately we would not be surprised if some of this earnings growth continues, but that is not the broader story,” Larry McDonald, head of U.S. macro strategy at ACG Analytics, told CNBC. “In terms of share price, these stocks will be a lot more concerned with what is going on in Europe. Once we return to a toxic DB [Deutsche Bank] atmosphere that was prevalent just a few weeks ago, US financials will drop.”

Italian banks have been under pressure to sell assets to support their troubled balance sheets. Italy’s fragile banking sector, the largest sector allocation in EWI, is in focus as global market participants fret about Brexit’s impact on Italy’s banks. The Italian government has been under pressure to calm concerns over its ailing banking system, which underperformed in the European Central Bank’s 2014 financial stress test and is holding €360 billion, or $410.5 billion, in bad loans.

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