Riding a stock market surge driven by expectations that the Federal Reserve could be done raising interest rates and that a “soft landing” in the US economy was now feasible, investors drove bank stocks higher last week.
Last Tuesday, two key indices that measure the banking sector saw their largest one-day increases since May 2020 after inflation data revealed price pressure was moderating earlier than anticipated.
The KBW Nasdaq US bank index (~BKX) and the KBW Nasdaq US regional bank index (~KRX), which are the identical indices, are likewise expected to exhibit their highest monthly gains in almost three years. Between the start of November and now, both have increased by around 13%.
However, economists warn that many banks still face a long list of challenges that are projected to endure far beyond 2024, so they are not yet ready to say that the worst is over for the industry.
Compared to the first half of the year, when the collapses of Silicon Valley Bank, Signature Bank, and First Republic caused concerns about the stability of several other mid-sized banks in the US, regional banks are undoubtedly in a more solid position.
However their capacity to generate more substantial profits continues to be hampered by high bond yields and interest rates, which translate into more costly deposits, more paper losses on investment bonds, and challenges for borrowers.
Potentially even more detrimental to the future viability of some of these mid-sized banks are new capital requirements that US authorities have recommended. The regulations, which are scheduled to take effect in 2025, are presently the focus of intense discussion in Washington.
Even though they have recovered from the beating they suffered in the spring, regional bank stocks have clearly underperformed the S&P 500 this year. When compared to the performance of the S&P 500, the KBW Nasdaq US bank index and the KBW Nasdaq US regional bank index are actually still trading at almost all-time low levels.
The optimistic scenario for banks is that a recession won’t materialise in 2024 and that peak interest rates have already passed. Many on Wall Street are already speculating that the Fed will start reducing rates next year, which may reduce the industry’s deposit costs and boost profitability.
The Fed funds rate has been rising at its fastest rate since 2001, with a target range of 5.25% to 5.50%, after the most aggressive rise programme since the 1980s.
Though “we’re gonna go right back the other way” when the US Treasury auctions off long-term debt and bond rates climb once more, bank analyst Chris Whalen said, “it’s nice to see this rally.”
Financial conditions might yet tighten considerably since the Fed’s “higher for longer” interest rate campaign is predicted to hold down economic activity. Furthermore, bank stocks may be in for further difficulties if inflation picks back up and the Fed is compelled to keep hiking rates.
According to RBC banking analyst Gerard Cassidy, the great majority of long-term investors are still underweight banks and have no intention of raising their holdings.
They’re “taking a wait and see attitude and I think they’re going to need to see further evidence that a soft landing is going to show up for them to jump in with both feet,” Cassidy stated. He also stated that there will be a “pivotal moment” when the Fed completely announces that it is done hiking rates.
“Rates will decline when [the Fed] signals they are finished. Investors will know that the economy is going to pick up steam if they don’t drastically lower rates.”
Goldman Sachs’ senior US equities strategist, David Kostin, identified commercial real estate as a recognised risk for the upcoming year.