The Federal Reserve’s aggressive start to monetary policy easing raised optimism among investors who expect this move to boost the profitability of Wall Street giants and smaller regional lenders. 

On Wednesday, the Fed Chairman, Jerome Powell, remarked the U.S. economy is "in good shape." He pointed out that risks of further cooling in the labor market have risen. 

With this, the central bank cut the interest rates by 50 basis points, bringing the Fed fund rates to the 4.75-5% range. This marks the end of an era of aggressive interest rate hikes intended to curb persistent inflation. The central bank also indicated two more rate cuts this year, which will bring the Fed funds rate down to 4.4% in 2024.

Investors see this rate cut as a big support to the economy with the expectation of a soft landing, where the Fed's aggressive tightening cycle ends with inflation falling to the 2% target without a significant downturn in the economy.

The U.S. Stock Markets React Positively to Jumbo Rate Cut

The Fed interest rate cut leads to a rally in the U.S. stock market, with the S&P 500 rising 1.7% and the tech-heavy Nasdaq Composite gaining 2.5%. The Dow Jones Industrial Average rose 1.3% on Thursday.

The KBW Nasdaq Bank Index and the S&P Banks Select Industry Index moved up 2.6% each yesterday. With this, shares of Citigroup C gained 5.2%, Wells Fargo WFC was up 2.3% and JPMorgan JPM rose 2.9%.

Apart from big industry players, lenders with excessive real estate exposure attracted investors’ attention. Hence, First Foundation Inc. FFWM stock jumped 4.5%, while HomeTrust Bancshares HTBI gained 2.2%, as the long-awaited rate cut is likely to be a favorable factor. 

Investors’ optimistic stance on banks with a huge commercial real estate (CRE) loan concentration was driven by the expected reduction in some of their credit risk and increased profits. Many banks have set aside huge amounts as a cushion against potential defaults among borrowers, particularly in their CRE portfolios where a lack of demand for office spaces led to immense pressure. 

As of June 30, 2024, FFWM had a real estate loan exposure of 71.5% of total loans, while for HTBI it was 50.6%.

Fed Rate Cut: How Will This Affect Banks?

The banks reaped huge benefits in the form of higher net interest margin (NIM) and net interest income (NII) during the initial phase of high-rate regime. Challenges related to slowing loan growth (mainly CRE), increased funding costs, lower-yielding securities and lower liquidity became more apparent since the beginning of 2023. 

As the Fed has cut the interest rates, funding costs will gradually stabilize and eventually start declining, thus supporting NII. Lower rates will also result in a gradual improvement in banks’ asset quality as borrowers repay loans. 

The lending scenario, which has been subdued of late, is expected to improve as the lower rate ignites demand for loans. Banks like C, WFC and JPM are expected to benefit from a rebound in loan demand.

Lower interest rates can narrow the spread between what banks pay on deposits and what they make on loans (i.e., the net interest margin), possibly reducing bank earnings in the near term. Banks frequently keep huge amounts of fixed-income securities, which give lesser profits when interest rates are reduced. 

Even though the rate cut offers hope to U.S. banks, it will take a longer time for the benefits of the same to be visible in their financials. We will have to wait to see how banks navigate through this rate cut to optimize their financial performance.

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