Interest rate cuts would be a tailwind for banks in 2024

The regional bank collapse of early 2023 shook the financial sector and set the tone for banks for the rest of the year. Big Bank CEOs testified before Congress last week, responding to lawmakers' new capital requirement proposals.

RBC Capital Markets Managing Director Gerard Cassidy joins Yahoo Finance Live to discuss how bank stocks could be expected to react to the Federal Reserve's interest rate pause in December, the potential for a 2024 soft landing, and current credit conditions.

"If rates were to come down and refinancing activity picks up at the long end of the curve, we don't want the Fed cutting too aggressively because that would suggest maybe the economy is weaker than expected," Cassidy explains, "but if you get one or two Fed fund rate cuts in 2024, the yield curve starts to come down a bit — that's very positive for the banks because the credit picture really improves..."

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

This post was written by Luke Carberry Mogan.

Video Transcript

JOSH LIPTON: It's been a nice run for some of these names.

I'm looking at the KBW, Gerard, it's up nearly 20% in the past four weeks.

What is-- what is driving that, Gerard?

Is that rates?

Is it, you know, credit?

What's driving that move?

GERARD CASSIDY: It's a good observation, because from the October lows, the banks are really outperforming the market.

Year-to-date, of course, as you've just shown on your screen, there have underperforming-- they have underperformed the market.

But since October, they've really outperformed the market, and it's been driven by a couple of factors.

First and foremost, I think what the market is deciphering is that the Federal Reserve, you know, obviously, they came out yesterday and pointed this out-- excuse me.

But the Federal Reserve looks like they're at their terminal rate for Fed funds.

And that, in the last four tightening cycles, has been the catalyst to get bank stocks to move higher.

Second, there's an increasing possibility or probability we're going to have a soft landing in the economy.

And if we do do that with the terminal rate for Fed funds, this is shaping up to look like 1995 when the stocks are up 55% that year.

So those are the two main factors.

But also, the long end of the curve, the 10-year government Treasury, in October, was up against 5%.

There was talk of maybe 6% in the 10-year.

And today it broke 4% on the downside.

That's been another factor for that move as well.

JULIE HYMAN: Gerard, when you look at rates, though, is that on balance, a headwind or a tailwind, rates coming down, that is?

GERARD CASSIDY: I would say it's a tailwind, because, if rates come down, the economy is going to be stronger.

And we always have to remember in bank stock investing, credit trumps interest rates.

And so if rates were to come down and refinancing activity picks up at the long end of the curve, if the Fed-- we don't want the Fed cutting too aggressively, because that would suggest maybe the economy is weaker than expected.

But if you get one or two Fed fund rate cuts in 2024, the yield curve starts to come down a bit, that's very positive for the banks, because the credit picture really improves.

And when you talk to investors today, many long lonelies, their number one concern about owning a bank stock going into '24 is the fear of credit problems.

And if you start taking that off the table, the stocks are going to work better.

So lower rates would be positive in our view because it suggests credit won't be that material of a problem.