Fed policymakers decided to lower their benchmark rate by 50 basis points — the first cut since 2020. Ahead of the Wednesday announcement, Fed Funds Futures showed market participants divided between expectations for a cut of a quarter point and a half point.
Bank investors welcomed the news, interpreting it as confirmation from the Fed that it
The KBW Nasdaq Bank Index closed Wednesday up slightly — less than half a percentage point — but it rallied more than 1% in the hour after the Fed's afternoon announcement.
The bank index had drifted in a narrow range after Fed Chair Jerome Powell said in late August at symposium in Wyoming that
"We are not on a pre-set course," Powell said during a press conference Wednesday. He said policymakers would "carefully assess" updated data and economic outlooks at its upcoming meetings in November and December. But he said the Fed's projections show more rate cuts are likely in the months ahead. "We're going to be making decisions meeting by meeting."
Asked why the Fed went with the bigger half-point cut, Powell said it reflected "confidence" in lower inflation as opposed to intensifying worry about the economy.
"We made a good strong start to this," Powell said. "The U.S. economy is in good shape…We want to keep it there. That's what we are doing."
Initially, lower rates could hamper banks' profitability, but they should bolster lenders over the coming year, said Allen Tischler, senior vice president at Moody's Ratings.
"We expect their deposit costs to reprice downward more slowly than their loan yields, constraining net interest income, which is most banks' largest revenue source," he said in an email. Longer term, however, "reductions in deposit costs will catch up and strengthen net interest income. Additionally, if lower rates prolong economic growth, it will help banks maintain and improve their asset quality… because lower rates make debt payments more affordable for borrowers with floating-rate loans.
"And, borrowers with maturing loans that need to refinance may be able to do so at lower interest rates. In addition, if lower rates help sustain" economic growth "in line with our estimate of 1.8% for 2025, the jobs market will remain stable and support consumer asset quality, which is correlated with the unemployment rate."
Allen Puwalski, chief investment officer at Cybiont Capital, agreed.
"The credit quality benefit will offset any pressure on net interest margin," Puwalski, who is also an independent director at the $119 billion-asset New York Community Bancorp, said in an interview.
He expects multiple rate reductions over the course of several months. "An orderly reduction in rates would be great for most of our banking system," he said.
Puwalski also noted upside for banks' securities portfolios.
When interest rates are high, for example, mortgage-backed securities prices fall because investors can earn higher yields from new securities, depreciating the value of existing holdings. At the same time, many banks that borrowed to maintain required capital levels saw the cost of that borrowing exceed the income from their mortgage-backed securities, creating negative carry. As rates come down, this process will unwind and benefit these banks, Puwalski said.
All of that noted, Puwalski said the more aggressive half-point cut signals the Fed views the economy as vulnerable.
Patrick Ryan, president and CEO of the $3.6 billion-asset First Bank in Hamilton, New Jersey, agreed. But he, too, sees lower rates ultimately supporting borrowers' ability to repay loans and benefiting banks.
"There is some caution out there, but things are holding up pretty well," Ryan said in an interview. "Lower rates could help borrowers and the economy, and that's ultimately good for banks because it means our credit costs will continue to be manageable."
"We will have work to do to manage our profitability, but we're in pretty good shape," Ryan added.
The Fed lifted rates at the fastest pace in four decades between March 2022 and July 2023, to a range of 5.25% and 5.5%. It had kept its target rate at that level to tame inflation that soared amid pandemic-induced supply-chain snarls, stout government stimulus programs, and Russia's invasion of Ukraine. Elevated rates drove up deposit costs for banks and, at the same time, slowed loan demand.
The Fed's aggressive action proved effective as inflation eased to a three-year low in August, the Bureau of Labor Statistics reported. After topping 9% in 2022, the federal consumer price index rose at a 2.5% annual pace last month. That was within striking distance of the Fed's 2% target.
Fed officials had said over the past couple weeks that they were poised to shift their attention away from inflation and toward supporting job growth and continued economic expansion. High rates had tamed inflation but also begun to impact hiring and economic activity.
The Labor Department said U.S. employers added
U.S. gross domestic product, the broadest measure of economic activity, advanced at an annual growth rate of 3% in the second quarter, according to the Bureau of Economic Analysis. However, that was down from a quarterly peak of 5% in 2023. The Atlanta Fed's updated estimate as of Wednesday pegged
