Banking on Rate Cuts

It's time for rate cuts.

Jeremy Powell has said the time has come. Inflation is still a little higher than they would like, but the main focus now is on the employment numbers which have been weakening and the Fed doesn't want to be caught off sides again; waiting too long to adjust policy like they did as the pandemic was ending. Some expect up to 4 cuts this year and as many as 9 next year, with a possible goal of 3% by the end of next year.

So what does all this all this have to do with banks and more importantly how will this rate cuts benefit banks?

First, we need to know how banks make most of their money. A bank takes in deposits at a certain interest rate and then leads that money out at, preferably, a higher interest rate. This is known as the bank's spread and the difference between the two rates are its profit.  

To attract money, banks set their rates at and attractive level, which is usually above the fed funds rate and more importantly the risk free short term treasury rate. The current problem is that the fed rate is high while, at the same time there is a cap on how much interest they can charge on loans. Americans and the housing market was starting to buckle when rates hit nearly 8%. This means that bank revenue and profits were squeezed. 

This doesn't mean that the banks were on the cusp of failure. In fact, the banks didn't do too bad during this time. Since 2021, JPMorgan missed earnings on only one quarter. Same with Bank of America. Even many of the smaller regionals have beat earnings estimates since 2021. But with the rate cuts, the banks have a chance for a wider profit margin. 

When we were in a period of rising interest rates, banks were quick to raise their rates. Of course, they had to raise the rates on the money they borrowed, such as savings, etc, which created a bit of a squeeze. However, like with most items, they are quick to raise rates but slow to lower them; at least with the money they lend out. With rates going down, they can afford to lower the rates that they have on savings accounts while keeping the rate on lending higher. This will create a wider spread and a greater stream of revenue; at least for a period of time. Eventually, competition will lower the lending rates. But with demand for debt still high, I don't see this happening at least until the end of 2025. 

So how would I play this? If I want to be safer, I'd be looking at JPMORGAN or even a Bank of America. If you want a little bit more risk, I'd go for some of the regionals. But overall, the choice is clear, in the season of falling interest rates, I want to be in banks.

*This is solely my personal thoughts and opinions and not to be taken as financial advice. For that, please contact your financial advisor