The Fed's policy shift is imminent, regional banks may gradually emerge from the predicament

According to the financial news app Zhitong Finance, the Federal Reserve's policy shift has led some investors to bet that US bank stocks are expected to rise, as rate cuts will provide much-needed support to some struggling banks. This bet has driven the KBW Nasdaq Regional Bank Index, which tracks medium-sized regional banks, to rise by 5% last Friday, marking the largest single-day gain for the index since 2024.

Federal Reserve Chairman Powell stated at the Jackson Hole Global Central Bank Annual Meeting last Friday, "We are not seeking nor welcoming further cooling of the labor market. The upward risks of inflation have diminished, while the downward risks of employment have increased. It is time to adjust the policy." This statement is seen by the market as a direct hint that the Fed will start cutting interest rates in September.

The KBW Nasdaq Regional Bank Index has risen nearly 5% year-to-date, lagging behind the broader banking industry tracked by the KBW Bank Index, which has risen over 18% so far this year. Eric Wallerstein, Chief Market Strategist at Yardeni Research, said, "There may be a catch-up trade for regional banks." He added that the Fed's gradual rate cuts over the next six months "will be very helpful for banks with quite poor credit quality."

In fact, two regional banks with significant loan exposure to weak commercial real estate, New York Community Bank (NYCB.US) and Silicon Valley National Bank (VLY.US), both rose by over 8% last Friday.

However, rate cuts are not an automatic victory for banks, especially if the Fed ends up increasing the rate cut magnitude or pace to prevent an economic downturn. Eric Wallerstein said, "The worst outcome for banks right now is definitely an economic slowdown."

Ibrahim Poonawala, a bank stock analyst at Bank of America Securities, said that the slower the Fed cuts rates, the greater the opportunity for banks to adjust their balance sheets. For many banks, the biggest benefit of Fed rate cuts is that they can reduce interest payments to depositors, and lower interest rates may also reduce the unrealized loss levels of regional bank bond portfolios. These are important steps to improve banks' net interest margins. However, the yields on banks' floating-rate loans and bonds will also start to decline, which could push profit margins in another direction.

Ibrahim Poonawala said, "In the next one or two quarters, you may see the negative impact of asset repricing speed being faster than the cost of financing, and we are still waiting for loan demand to recover, which will be a drag factor."