Investors are betting that a potential pivot from Federal Reserve Chair Jerome Powell will provide much-needed relief for beleaguered regional banks. The optimism surrounding a shift in Federal Reserve policy has led to a significant boost in US bank stocks, with expectations that lower interest rates could help struggling lenders.
On Friday, the KBW Regional Bank Index (^KRX), which tracks mid-sized regional banks, surged 5%, marking its largest single-day gain of 2024. The index managed to hold these gains into Monday.
This notable increase followed Powell’s indication that “the time has come to adjust policy,” hinting at the first Federal Reserve rate cut in over four years. As a result, an index covering the broader banking sector (^BKX) has risen more than 18% year-to-date, mirroring the performance of the S&P 500 (^GSPC).
Despite these gains, regional banks are still lagging behind the broader industry. The KBW regional bank index (^KRX) has only seen a 6% increase, highlighting a potential for further catch-up.
Eric Wallerstein, chief markets strategist at Yardeni Research, suggested that incremental rate cuts over the next six months could be beneficial for banks grappling with poor credit quality. “There will likely be a regional bank catch-up trade,” Wallerstein told Yahoo Finance.
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For instance, regional banks with significant exposure to weakened commercial real estate, such as New York Community Bank (NYCB) and Valley National Bank (VLY), each saw their stock prices jump by 9% on Friday.
However, the path to recovery is not guaranteed. Wallerstein warned that deeper or faster rate cuts, if implemented to prevent a recession, could have adverse effects. “Guaranteed the worst outcome for banks right now is an economic slowdown,” he added.
Lower rates would enable banks to reduce the interest paid to depositors and alleviate some unrealized losses on their bond portfolios, which is crucial for improving net interest margins.
Yet, the reduction in yields from floating rate loans and bonds could potentially offset these benefits, impacting profit margins negatively.
