Finance

Falling interest rates are usually good news for banks, especially when the cuts aren’t a harbinger of recession.
But the ride probably won’t be a smooth one: Persistent concerns over inflation could mean the Fed doesn’t cut rates as much as expected and Wall Street’s projections for improvements in net interest income may need to be dialed back.
While all banks are expected to ultimately benefit from the Fed’s easing cycle, the timing and magnitude of that shift is unknown, based on both the rate environment and the interplay between how sensitive a bank’s assets and liabilities are to falling rates.

Federal Reserve Board Chairman Jerome Powell holds a press conference following a two-day meeting of the Federal Open Market Committee on interest rate policy in Washington, U.S., September 18, 2024. REUTERS/Tom Brenner
Tom Brenner | Reuters

Falling interest rates are usually good news for banks, especially when the cuts aren’t a harbinger of recession.
That’s because lower rates will slow the migration of money that’s happened over the past two years as customers shifted cash out of checking accounts and into higher-yielding options like CDs and money market funds.

When the Federal Reserve cut its benchmark rate by half a percentage point last month, it signaled a turning point in its stewardship of the economy and telegraphed its intention to reduce rates by another 2 full percentage points, according to the Fed’s projections, boosting prospects for banks.
But the ride probably won’t be a smooth one: Persistent concerns over inflation could mean the Fed doesn’t cut rates as much as expected and Wall Street’s projections for improvements in net interest income — the difference in what a bank earns by lending money or investing in securities and what it pays depositors — may need to be dialed back.
“The market is bouncing around based on the fact that inflation seems to be reaccelerating, and you wonder if we will see the Fed pause,” said Chris Marinac, research director at Janney Montgomery Scott, in an interview. “That’s my struggle.”
So when JPMorgan Chase kicks off bank earnings on Friday, analysts will be seeking any guidance that managers can give on net interest income in the fourth quarter and beyond. The bank is expected to report $4.01 per share in earnings, a 7.4% drop from the year-earlier period.

Known unknowns

While all banks are expected to ultimately benefit from the Fed’s easing cycle, the timing and magnitude of that shift is unknown, based on both the rate environment and the interplay between how sensitive a bank’s assets and liabilities are to falling rates.

Ideally, banks will enjoy a period where funding costs fall faster than the yields on income-generating assets, boosting their net interest margins.
But for some banks, their assets will actually reprice down faster than their deposits in the early innings of the easing cycle, which means their margins will take a hit in the coming quarters, analysts say.
For large banks, NII will fall by 4% on average in the third quarter because of tepid loan growth and a lag in deposit repricing, Goldman Sachs banking analysts led by Richard Ramsden said in an Oct. 1 note. Deposit costs for large banks will still rise into the fourth quarter, the note said.
Last month, JPMorgan alarmed investors when its president said that expectations for NII next year were too high, without giving further details. It’s a warning that other banks may be forced to give, according to analysts.
“Clearly, as rates go lower, you have less pressure on repricing of deposits,” JPMorgan President Daniel Pinto told investors. “But as you know, we are quite asset sensitive.”
There are offsets, however. Lower rates are expected to help the Wall Street operations of big banks because they tend to see greater deal volumes when rates are falling. Morgan Stanley analysts recommend owning Goldman Sachs, Bank of America and Citigroup for that reason, according to a Sept. 30 research note.

Regional optimism

Regional banks, which bore the brunt of the pressure from higher funding costs when rates were climbing, are seen as bigger beneficiaries of falling rates, at least initially.
That’s why Morgan Stanley analysts upgraded their ratings on US Bank and Zions last month, while cutting their recommendation on JPMorgan to neutral from overweight.  
Bank of America and Wells Fargo have been dialing back expectations for NII throughout this year, according to Portales Partners analyst Charles Peabody. That, in conjunction with the risk of higher-than-expected loan losses next year, could make for a disappointing 2025, he said.
“I’ve been questioning the pace of the ramp up in NII that people have built into their models,” Peabody said. “These are dynamics that are difficult to predict, even if you are the management team.”

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The consumer price index rose by 2.4% in September 2024 on an annual basis, according to the Bureau of Labor Statistics.
Inflation declined amid a pullback in gasoline prices and moderation in housing inflation.
There were some trouble spots, however, such as groceries and car insurance.

David Paul Morris/Bloomberg via Getty Images

Inflation fell in September as lower gasoline prices combined with other waning price pressures in areas such as housing to bring relief to consumers’ wallets, according to the U.S. Bureau of Labor Statistics.
The consumer price index, a key inflation gauge, was up 2.4% last month from September 2023, the bureau said.

That figure is a decline from 2.5% in August, meaning price growth slowed. It’s also the smallest annual reading since February 2021.
The September CPI figure was slightly higher than economists predicted, however.
There were some trouble spots, such as an uptick in categories including clothing, car insurance and groceries. Most appear to be “one-off” increases, though, said Mark Zandi, chief economist at Moody’s.
“The trend on inflation remains very positive,” Zandi said. “This month was a blip and I don’t think it will be sustained.”

The CPI measures how quickly prices are rising or falling for a broad basket of goods and services, from car repairs to peanut butter and living room furniture.

Inflation has pulled back significantly from its pandemic-era peak of 9.1% in June 2022. It’s moving toward policymakers’ long-term annual target, near 2%.

“We have made substantial improvement over the past two years,” said Sarah House, senior economist at Wells Fargo Economics.
That said, a slowdown in the labor market has concerned economists more than inflation in recent months.
The U.S. Federal Reserve, which had raised interest rates sharply to combat high inflation starting in early 2022, began cutting them in September to take pressure off the labor market and economy.

Prices fall at the gas pump

Annual food inflation is ‘fairly tame’

Frederic J. Brown | AFP | Getty Images

Food inflation over the past year has also been “fairly tame,” House said.
Grocery prices are up 1.3% since September 2023, according to the CPI.
Prices for agricultural commodities — a “major input cost” for food — have either fallen or look “more stable,” House said. Examples of agricultural commodities include corn, wheat, coffee and soybeans.
Wage growth has slowed, reducing labor costs to transport or prepare food, for example, House said. And grocery stores have offered more price incentives and promotions as consumers become more concerned about their spending, she said.

That said, grocery inflation did see a large jump on a monthly basis from August to September, to 0.4% from 0%.
“I don’t think that will be sustained going forward,” Zandi said.
Individual food items have their own unique supply-and-demand dynamics that can affect pricing.
For example, egg prices rose by more than 8% from August to September, and by 40% since September 2023, largely due to another outbreak of avian flu, a contagious and lethal disease that affects chickens and other birds, said economists.

Housing inflation is declining

Housing accounts for the largest share of CPI — and has been the biggest stumbling block in getting inflation back to its target level, economists said.
“It’s a huge component,” House said. “What happens there can really move the dial when it comes to overall inflation and core inflation.”

CPI shelter inflation — which includes rental prices and an equivalent measure for homeowners — has gradually declined but remained stubbornly high. That has puzzled many economists, since real-estate data shows that growth for average rents of new tenants has been muted for about two years.
In September, shelter inflation throttled back on a monthly basis, to 0.2% from 0.5% in August.
That’s among the most encouraging signals in the latest CPI report, economists said.
“Shelter inflation is now definitively moderating,” Zandi said. “And that’s such a key part of the CPI.”

‘Slower to recede’

Housing falls into the “services” category of the economy.
Inflation for goods has largely throttled back from pandemic-era nosebleed levels as out-of-whack supply-and-demand dynamics unwind, economists said.
But services inflation “has still been pretty slow to recede,” House said.
Largely, that’s been because of shelter. But other categories also remain elevated.

Many services “rely heavily” on prices in other parts of the economy, House said. For example, insurers are now raising car insurance premiums following an earlier surge in new and used car prices.
Prices for motor vehicle insurance increased 1.2% from August to September and about 16% since September 2023, according to the CPI.
It typically takes a while for such dynamics to filter through, on paper, to the services side, she said.
“Services inflation was slower to peak on the way up and likely to be slower to recede on the way down,” she said. More

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