Introduction

The Financials sector is poised to dominate market attention this week. Key financial institutions such as Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo are set to disclose their earnings results, offering critical insights into sector performance. Major banks find themselves in a significantly different economic environment compared to just a quarter ago. Declining interest rates, changing government policies, and mixed market conditions will likely dominate discussions as financial institutions reveal their performance and outlook for 2025.

Interest Rate Changes and Their Mixed Impact

Back in September 2024, the Federal Reserve started the easing cycle with a 50-basis-point rate cut, sparking optimism for increased banking activity. However, recent developments have painted a more complex picture. Following two additional 25-basis-point rate cuts, bringing the total to 100 basis points in 2024, Treasury yields have risen by more than 100 basis points from their September lows and are nearing their 2024 highs as the Fed lowered its rate cut expectations for 2025 amid stubborn inflation. The current economic scenario presents a mixed picture for banks, as interest rate fluctuations significantly impact their financial activities.

Lower rates typically boost growth for banks by stimulating demand for services such as mortgage lending and IPO underwriting while reducing interest paid on deposits. Conversely, rising yields can suppress demand for these services but increase net interest income (NII), which is the difference between lending rates and deposit expenses. The recent steepening of the yield curve, with higher long-term yields relative to short-term yields, could cause mortgage refinancing and application volumes to decline, while increased NII offers a potential upside.

Banks heavily dependent on retail and corporate lending could face challenges due to the prolonged higher-rate environment. Regional banks with extensive commercial loan portfolios may be particularly vulnerable. Conversely, Wall Street giants, which have leveraged NII gains from rising rates over recent years, stand to benefit from a steepening yield curve.

Q4 Earnings Growth and Outlook for 2025

According to Factset, the Financials sector is expected to report the highest year-over-year earnings growth rate of 39.5% of all eleven sectors within the S&P 500 for Q4. Big banks played a significant role in driving the nearly 40% earnings growth in the financial sector during 2024. However, a portion of this impressive growth was due to favorable year-over-year comparisons, as the prior year’s earnings were impacted by substantial charges, including Federal Deposit Insurance Corporation (FDIC) special assessments that lowered their 2023 EPS.

While net interest margins (NIMs), loan growth, and deposit inflows are anticipated to be positive factors, noninterest income and the impact of elevated long-term rates may pose challenges for many banks. The key focus will likely be on updated forward guidance during earnings calls, which is expected to lean bullish due to a steeper yield curve and growing optimism around a more favorable regulatory environment—conditions not seen in years.

Overall, Q4 bank results are expected to present a mixed picture. However, with bank stocks trading at historically moderate valuations amid solid earnings growth forecasts, market expectations appear relatively modest, setting the stage for upside surprises.

While larger banks dominate headlines, smaller regional banks set to report next week could provide valuable insights into grassroots trends, such as consumer loan demand and small business lending activity. These institutions often offer a granular view of economic conditions on the ground.

Looking ahead, earnings growth rates for the financial sector in 2025 are expected to moderate significantly. Analysts forecast financial stocks growing earnings per share just 9%, below the anticipated 14.8% growth for the broader S&P 500. This decline could be attributed to the prolonged higher-rate environment and tougher year-over-year comparisons.

Source: TradingView

Upcoming changes in government policies under the new U.S. administration could influence the banking sector. Potential changes to taxation and regulatory frameworks are poised to impact corporate and personal financial behaviour. However, the economic impact of the proposed tariff and immigration policies remains unclear.

While reduced corporate taxes could stimulate investment and borrowing activity, proposed tariffs and stricter immigration policies may fuel inflationary pressures, possibly resulting in higher for longer interest rates.

Concerns over potential inflation resulting from these measures have already unsettled markets, pushing Treasury yields higher in December. This market anxiety intensified after the Federal Reserve signalled a pause in rate cuts until inflationary pressures ease.

Tariffs, which can be swiftly imposed through executive orders, have proven easier for administrations to implement than corporate tax reductions, which require legislative approval. While tariffs are less beneficial to banks, tax cuts can stimulate broader economic activity, benefiting financial institutions. The recent budget battles demonstrate that securing Congressional support for fiscal measures remains a challenge, even within the president’s party.

Political and economic uncertainties have influenced market sentiment. Initially, bank stocks surged post-election, however, inflation concerns linked to policy changes dampened this optimism, causing the financials index to decline. The financial sector still gained 28% in 2024, outperforming the broader S&P 500 Index, which rose 23% during the same period.

Amid these uncertainties the financial sector declined from its record high of 857 in December 2024 to a low of 783 on Monday, in close proximity to dynamic support of 775, where the current pull back could start stabilising. And while volatility is likely to increase in 2025 and growth likely to moderate, levels to 940 by year end appear achievable.

Optimism Amid Challenges for Banking Giants

As financial powerhouses such as JPMorgan Chase, Citigroup, and Wells Fargo prepare to release their earnings reports, the outlook is not entirely bleak. While interest rates remain elevated compared to the near-zero levels seen from 2008 to 2021, one key driver keeping rates stubbornly high is the robust U.S. economy. The Atlanta Federal Reserve’s GDPNow tool recently estimated fourth-quarter GDP growth exceeding 3%, following a similarly strong performance in the third quarter.

A healthy economy traditionally supports the banking sector by driving demand for financial services. Although a slowdown in GDP growth over the coming months is expected, optimism remains around potential business-friendly tax and regulatory reforms under the incoming U.S. administration. Such changes could invigorate mergers and acquisitions (M&A) activity and boost lending growth, even with interest rates holding near 4%, provided economic expansion continues.

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