Big Wall Street banks and interest rates have a complicated relationship. As the Federal Reserve on Wednesday afternoon embarks on easing monetary policy, banks are hoping for a more normalized bond market yield curve, with a wider spread between the short end and the long end. Banks make interest income by paying for deposits at a lower rate and lending at a higher rate. They also make money on fee-based services in businesses that pick up when rates are lower. “These banks are pretty sophisticated,” Erica Groshen, former New York Fed vice president, told CNBC in an interview. “They have been managing their risk all along knowing that eventually, interest rates were going to come down.” Groshen, a senior economic advisor at Cornell University, added, “The Fed has been doing a pretty amazing job of getting very close to a soft landing” as a stable economy can lift all boats. On the interest side, banks pull levers and push buttons to make the best of any rate environment. But the clearest line of sight to the benefits of lower rates is in investment banking because cheaper borrowing costs tend to encourage more mergers and acquisitions and initial public offerings. Banks take fees from clients putting together deals and taking their companies public. For Morgan Stanley , a rebound in capital markets is crucial to the Club’s investment thesis. While diversifying in recent years to become less dependent on investment banking, it’s still a big part of the business. When the Fed started hiking rates in March 2022, M & A and IPO activity grounded to a halt. Would-be clients sought to conserve capital on concerns about a recession. Dealmaking, however, has picked up this year on the prospects of lower rates. The Club has stayed with Morgan Stanley on expectations that its investment banking outfit will flourish again. MS YTD mountain Morgan Stanley (MS) year-to-date performance There has been some progress so far. Morgan Stanley was tapped for high-profile deals like Reddit’s IPO in March. Investment banking, which falls under Morgan Stanley’s Institutional Securities, accounts for roughly 46% of overall revenue. The division handily beat on second-quarter revenue . Morgan Stanley’s IB revenue increased 53% year-over-year, while advisory fees and equity underwriting fees jumped more than 30% and 56%, respectively. Still, Jim Cramer recently said there have not been enough signs of a recovery at Morgan Stanley. The stock’s underperformance compared to peers and the market has disappointed him. Shares of Morgan Stanley are up 7% year to date, versus the KBW Bank Index ‘s nearly 17% gain and the S & P 500 ‘s 18% advance in 2024. Jim has said he’s considering swapping Morgan Stanley for his old shop Goldman Sachs . “Morgan Stanley is in no man’s land, too low to sell and too high to buy. That means wait, which is exactly what we are doing,” he said during last week’s September Monthly Meeting. “That said, I think we have battled enough.” At Wells Fargo , the Club’s other financial name, lower rates should help its burgeoning investment banking business. While known as a traditional money center bank, CEO Charlie Scharf has been diversifying the firm’s business mix. Wells Fargo shares year-to-date have performed better than Morgan Stanley, gaining 11%. However, the stock was still trailing KBW and the S & P 500 over the same stretch. WFC YTD mountain Wells Fargo (WFC) year-to-date performance The Corporate and Investment Banking division makes up 23% of overall revenue. However, management has made significant strides to expand CIB through a slew of senior hires. These investments are helping Wells Fargo to rely less on interest-based revenue streams, which are at the mercy of the Fed’s policy rather than management’s own strategy. “Wells is doing incredibly well and I think that CEO Charlie Scharf has a winning formula for when rates go down,” Jim said, referencing the firm’s CIB expansion. Investment banking at Wells Fargo houses its Commercial Real Estate portfolio — once one of the largest among big banks. The estimated $21 trillion CRE sector has experienced mounting troubles due to higher vacancy rates and higher odds of delinquencies. However, with rates coming down, Wells Fargo’s CRE exposure becomes less of a concern for investors because cheap borrowing costs lead to more property sales and rentals. To be sure, Wells Fargo management said during July’s second-quarter earnings call that the bank will continue to de-risk its office portfolio. (Jim Cramer’s Charitable Trust is long WFC, MS. See here for a full list of the stocks.) 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Federal Reserve Bank Chair Jerome Powell announces that interest rates will remain unchanged during a news conference at the bank’s William McChesney Martin building on May 01, 2024 in Washington, DC.
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Big Wall Street banks and interest rates have a complicated relationship.