Navigating the Shifting Tides: How the Fed's Rate Cuts Impact Big US Banks

As the third-quarter earnings season kicks off, investors are closely watching the impact of the Federal Reserve's recent rate cuts on the largest US banks. With JPMorgan Chase, Wells Fargo, Bank of America, and Citigroup set to report their results, the focus will be on how these institutions are adapting to the changing interest rate environment and its implications for their future profitability.

Uncovering the Ripple Effects of the Fed's Monetary Policy Shift

Margin Pressures and the Balancing Act

The big banks are expected to report a decline in net profits compared to the previous quarter and the year-ago period, as the elevated interest rates in place for most of the third quarter have chipped away at their lending margins. However, the more pressing question for investors is how the banks will navigate the future as borrowing costs start to drop. The institutions are already lowering the rates they charge new borrowers, cutting into a key source of interest income that had boosted their profits in 2022 and 2023 as the Fed pushed rates higher. Yet, there is also a chance that they may not have to pay as much to retain their customer deposits, which could potentially lower their costs and boost margins over time. Navigating this delicate balance will be crucial for the banks as they adapt to the Fed's new rate path.

JPMorgan Chase: The Industry Bellwether Faces Headwinds

JPMorgan Chase, the industry's largest bank, has been a standout performer in 2023, churning out record profits as the Fed's rate hikes fueled its net interest income. However, there are signs that this momentum is starting to wane, with the bank's executives warning that its net interest income expectations for 2025 may be "not very reasonable" due to the timing and effect of falling interest rates. This has led some analysts to downgrade JPMorgan's stock, citing less positive surprises ahead as the Fed eases its monetary policy. The bank's reliance on floating-rate loans and its relatively slower deposit rate increases during the tightening cycle could make it more vulnerable to the impact of rate cuts, as it may not benefit as immediately from cheaper funding as its regional bank counterparts.

Regional Banks: Poised for a Resurgence?

While the big banks may face challenges in the face of falling interest rates, the smaller regional lenders could be poised for a resurgence. These institutions saw their funding costs jump after the failures of Silicon Valley Bank and other sizable institutions in 2023, but as deposit rates start to come down, they stand to benefit from a "mean reversion" in their funding costs. According to analysts, earnings growth for large regional lenders is expected to catch up to their bigger peers over the next year, while small and mid-sized banks should also see a boost. Keycorp and PNC are among the regional banks that are expected to benefit the most from the Fed's rate cuts, as their funding costs are likely to decline more rapidly.

The Broader Implications: Dealmaking and Loan Demand

Despite the challenges facing the banking industry, many investors remain optimistic about the long-term prospects for the sector. The monetary policy easing could spur more dealmaking, which would benefit banks with significant investment banking operations. Additionally, the potential for increased loan demand from consumers and businesses could also provide a boost to the industry. As the high interest rates that have "worn out their welcome" start to subside, the banking sector may find itself in a more favorable position to capitalize on the changing economic landscape.