Bank Stocks Cheer for Lower Rates: Opportunity and Risk for the Banking Sector

Investors have been anxious about the Federal Reserve's effect on the economy, with concerns of it being late to respond to inflationary pressures and implementing interest-rate increases too quickly. Despite higher interest rates boosting lender profits, it can weaken loan demand and pressure banks to raise deposit rates for customers.

At the onset of QT, lenders were comfortable shedding deposits. That's because institutions had amassed trillions of dollars during the pandemic, they didn't mind seeing a lot of that leave once the Fed started raising interest rates in March 2022. In March 2023, the failure of California's Silicon Valley Bank and other institutions led to depositors pulling trillions from the banking system to shift to alternatives like money-market funds. Though the banking system has stabilized, they had to increase rates on certificates of deposit and other products to retain deposits at a cost. The rapid increase in interest rates caused damage to some areas of the economy, particularly in the financial sector. Customers withdrew their deposits to find higher-rate opportunities elsewhere, resulting in financial stocks suffering. Additionally, the steep rise in loan rates made bank customers hesitant to take out new loans.

• Rick Meckler, partner at Cherry Lane Investments in New Jersey, noted that rate cuts could boost the economy and bank profitability, along with rallying stock and bond markets benefiting large bank segments like wealth management, capital markets, and credit. According to Meckler, banks are among underperforming sectors trying to catch up in the market.

A specific worry is that commercial real estate could start producing major losses for regional banks, which are big financiers to office buildings across the US that emptied out during the pandemic and have not yet recovered pre-pandemic occupancy rates.

• "It is going to take some time for regional banks to repair their balance sheets," said Apollo's chief economist Torsten Slok in a recent note.