Fed Cuts Interest Rates by 50Bps: What This Means for Bank Stocks

In an aggressive start to its monetary policy easing, the Federal Reserve cut the interest rates by 50 basis points, bringing the fund rates to the 4.75-5% range.

This marked the end of an era of aggressive interest rate hikes to tame "persistent" inflation. The central also indicated two more rate cuts this year, which will bring the Fed funds rate down to 4.4% in 2024.

Following the announcement, the markets' reaction was subdued, and all three major indexes ended in red on Wednesday. On the other hand, indexes related to banks, including the KBW Nasdaq Bank Index and the S&P Banks Select Industry Index closed in green.

The interest rate cut is a positive development for banks like Bank of America BAC, Citigroup C and Comerica CMA. Banks have been reeling under increasing funding cost pressure. Though higher rates led to a significant jump in banks' net interest income (NII), the same resulted in increased funding costs, which squeezed the net interest margin.

As interest rates come down, funding costs will gradually stabilize and then decline. Hence, this will alleviate pressure on NIM to some extent.

On the other hand, JPMorgan JPM is expected to witness a fall in NII next year. The company's president and chief operating officer, Daniel Pinto, during the Barclays Global Financial Services Conference on Sept. 10, warned about a potential decrease in the metric in 2025 because of rate cuts.

What Else Did the Fed Signal?

In addition to this year's further reduction in interest rates, the Fed officials, through its dot plot, signaled four more cuts in 2025 and two in 2026.

This will bring the interest rates close to 2.9% by the end of 2026. It is lower than the 3.1% forecasted during the June FOMC meeting.
Fed's Dot Plot

Image Source: Federal Reserve

Additionally, the central bank came out with the latest summary of Economic Projects. Per the latest SEP data, the U.S. economy is anticipated to grow at the rate of 2% till 2026.

Moreover, the Fed officials noted that "job gains have slowed and the unemployment rate has moved up but remains low." They lifted their expected unemployment rate to 4.4% for 2024 from the 4% forecasted at the last update in June.

The central bank lowered the inflation target to 2.3% for 2024 from 2.6% predicted in June.

How Will Banks Be Impacted?

Apart from the above-mentioned decrease in funding costs, lower rates mean a rise in loan demand. The lending scenario has been muted as the central bank began tightening its monetary policy in March 2022. This had been hurting banks' financials immensely.

As the rates come down, loan demand is gradually expected to improve. The borrowers who have been on the sidelines because of higher rates are now expected to jump in.

Thus, banks including BAC, C, JPM and CMA are expected to benefit from a solid rebound in loan demand.

Lower rates will also result in a gradual improvement in banks' asset quality as borrowers repay loans.

Nonetheless, all of these are not expected to occur immediately, and investors should not expect a total turnaround in banks' financial performance, at least this year.

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