Party Like It’s ... 1995?

Do you think Ross and Rachel are finally going to get together? And what’s the deal with Beanie Babies? Excuse us, we’re just trying to get into a 1995 frame of mind—because some people think we may be headed there again.  

In 1995, the Federal Reserve’s rate cuts sparked one of the biggest rallies for bank stocks, with the sector outperforming the S&P 500 by more than 40%. Fast-forward to 2024, and we’re seeing some familiar conditions—and some exceptions, including the shape of the yield curve (see below).   

As of the beginning of this week, bank stocks were already up 19% for the year, and like 1995, there’s optimism that a big  “recalibration” could provide a significant boost for the sector. While economists and pundits try to process the potential impact of last week’s 50-basis-point reduction in the fed funds rate, there is already talk of more cuts on the horizon.  

“History isn’t likely to repeat, but it may rhyme,” said Mike Mayo, a Wells Fargo analyst who sees historical parallels. He noted that in previous cycles like 1995, 1998, and 2019, despite initial selloffs, banks outperformed the broader market after rate cuts—especially when the Fed managed to avoid a recession. 

However, 2024 presents a more complex picture. Back in 1995, banks benefited from a wide gap between short- and long-term interest rates, which allowed them to profit more easily. Today’s yield curve—even with last week’s drop in the fed funds rate—is far less favorable, and there’s uncertainty about whether the Fed can achieve the same “soft landing” that helped banks thrive in the mid-90s. 
 
The Fed sure seems optimistic, though. Harvard economist Jason Furman suggested the Fed’s latest projections of 2% inflation, steady growth, and low unemployment are “just about the closest thing to a ‘Mission Accomplished’ banner you can imagine them unfurling.” Treasury Secretary Janet Yellen echoed this optimism, calling the rate cut a “very positive sign” for the economy’s soft landing. However, Fed Governor Michelle Bowman, the lone dissenter on last week’s decision, warned that such a large cut could be seen as a “premature declaration of victory” over inflation. 

For banks, rising credit risks add to the complexity. As Russell Hutchinson, CFO of Ally Financial, noted, “Our credit challenges have intensified,” particularly in the retail auto sector. Banks are already preparing for higher loan loss provisions, which could weigh on their earnings as they navigate the current economic environment.