U.S. banks have reportedly gained a $1 trillion windfall due to the Federal Reserve's prolonged period of high interest rates.
What Happened: The Federal Reserve maintained elevated interest rates for two and a half years, allowing banks to earn higher yields on deposits held at the Fed. However, many banks did not pass these higher rates on to their savers, the Financial Times reported on Monday.
At the end of the second quarter, the average U.S. bank paid depositors an annual interest rate of just 2.2%, significantly lower than the Fed's 5.5% overnight rate. This discrepancy resulted in $1.1 trillion in excess interest revenue for banks, according to the Financial Times.
Large banks like JPMorgan Chase (NYSE: JPM) and Bank of America (NYSE: BAC) paid even less, with annual deposit costs of 1.5% and 1.7%, respectively. The Fed's recent rate cut by half a percentage point may allow banks to reduce deposit costs further, according to Chris McGratty of KBW.
While some banks, including Citi (NYSE: C), plan to adjust rates for high-net-worth clients in line with the Fed's cuts, others may vary in their approach. The Financial Times noted that this situation contrasts with Europe, where some governments imposed windfall taxes on banks benefiting from higher rates.
JPMorgan Chase, Citi and Bank of America have yet to respond to the queries by Benzinga.
Why It Matters: The Federal Reserve's recent decision to cut interest rates by 50 basis points in September, lowering the target range to 4.75%-5%, has significant implications. This bold move, which defied economists' predictions of a modest 25-basis-point reduction, was aimed at sustaining the labor market. Fed Chair Jerome Powell emphasized the importance of acting preemptively to maintain robust employment levels.
Additionally, the performance of the S&P 500 following the Federal Reserve's rate cuts hinges on whether the economy is in a recession. Historical data reveals a sharp contrast in how equities react to rate cuts during recessions compared to other economic phases. During recessionary periods, stock markets typically experienced meaningful declines after the Fed's initial rate cut. In contrast, during "growth scares" or "normalization" periods, equities have rallied strongly.
The Federal Reserve's decision to cut interest rates by 0.5% may also pull investors away from money market funds and into longer-duration bonds. Total money market fund assets decreased by $20.02 billion to $6.30 trillion for the week ending on September 18. Among taxable money market funds, government funds decreased by $18.82 billion and prime funds decreased by $2.42 billion.