The FOMC cut the target range for the Federal Fund rate by 25 basis points to a range of 4.25% to 4.5%. This was widely expected despite recent inflation readings. However, the Summary of Economic projections contained two meaningful adjustments to the outlook for 2025. First, the median estimate of core PCE inflation for 2025 rose to 2.5 percent, up from 2.1 percent in September. Consequently, the median estimate of the Fed Funds rate in December of 2025 moved up to 3.9 percent, half a percentage point higher than the median estimate in September. The 2025 estimates from FOMC members are tightly clustered around the median whereas the estimates for 2026 and 2027 are more widely dispersed reflecting a broader range of expectations with respect to market conditions further into the future.
As we’ve noted previously, banks entered this down cycle coming off an extended high-rate plateau in a low loan-growth environment with a flat to inverted yield curve. As a result, deposit costs moved up faster than asset yields at the end of the cycle, squeezing bank profits. Banks entered this falling rate cycle determined to flip the script and recover net interest margin, but there are obstacles to navigate in bringing costs down. These include non-interest-bearing deposits that can’t be priced down, back books of very low-rate savings balances, some of which continue to wake up, and natural churn as life events drive customers to shop for new banking relationships at front-book rates.
Commercial and Wealth Deposits
The net result has been very strong down-pricing performance in Commercial, where banks have accomplished overall betas of 43% so far in the cycle. The key driver here has been an ability to bring MMDA rates down nearly in step with the Fed, achieving a product-level beta of 75%.
Wealth has performed similarly , with 44% overall betas, even though nearly a quarter of customers have yet to receive any rate cut. This points to the competitiveness of retaining Wealth deposits, especially in the context of fluid management of customer liquidity across off-balance-sheet investments. In Wealth we’ve also been watching for a potential rotation of customer funds into investments because, by historical standards, Wealth clients are holding a lot of cash. But even recent strong stock market performance has failed to dislodge a significant chunk of that cash, and it does appear that higher levels of liquidity constitute a new normal in Wealth.
Refer to Figure 1 for data on deposits for Commercial, Wealth, Small Business and Consumer.
Figure 1: Falling Rate Deposit Beta | Aug ’24 – Nov ’24
Source(s): Curinos Deposit Analyzer
Small Business and Consumer Deposits
Turning to the other end of the spectrum, deposit costs have been stickier in Small Business and Consumer. In Small Business, preliminary data show betas of 22% through November, up from only 7% in October. Pushing rates lower in Small Business is particularly challenging because about two-thirds of Small Business deposits are still in non-interest-bearing products or low-rate products that can’t be priced down. Furthermore, betas on Small Business savings were only about 35%, owing to a larger back book of low-priced balances.
In Consumer, portfolio pass-throughs were very low following the first Fed cut but, as expected, have since picked up. Preliminary data show overall Consumer betas of 15% through November. Banks have lowered CD rates substantially and savings to a lesser extent. Still, half of Consumer deposits are in non-interest-bearing or low-rate accounts that cannot be repriced. Some of these customers are still waking up, rotating into higher rate products due to life events or simply because of a desire to lock in a little return on their deposits before the window of opportunity closes. This dynamic creates a drag on overall ability to down-price the portfolio.
Small Business Lending
While banks have reason to anticipate a gradual increase in Small Business lending activity in the new year, the falling rate environment also puts pressure on net interest margins for lenders, intensifying competition. According to Curinos’ LendersBenchmark for Small Business consortium, market demand declined slightly following the two most recent cuts, suggesting that business owners remain uncertain about the overall economic outlook despite lower borrowing costs (Figure 2). This adjustment is set to lower borrowing costs even further, and combined with the potential for more growth oriented economic policy in the new year, it may be the encouragement owners need to invest in growth or address operational needs.
Source: LendersBenchmark for Small Business Originations
Baseline: Units <$5MM
Yet, while borrowing costs have decreased, there’s still an imbalance between market demand and supply. The latest NFIB Small Business Optimism report shows that owners continue to find it difficult to obtain the credit they need despite these lower rates. The unmet demand in the market creates opportunities for lenders that can strategically balance portfolio growth and profitability goals while at the same time effectively managing credit risk.
Home Lending
While the Fed’s rate cuts most directly affect lending rates for home equity loans and unsecured/personal credit, it’s important to note that the Fed does not directly determine mortgage rates. Its actions, however, significantly influence market sentiment, inflation expectations and bond markets, all of which collectively shape their movements.
Recent volatility in key economic reports, particularly those related to inflation and unemployment, suggests that lenders should anticipate temporary fluctuations in interest rates as markets absorb the Fed’s decision and its economic projections. Because borrowers may encounter brief windows of lower rates amid this volatility, lenders should therefore position themselves strategically to serve prospective buyers looking to capitalize on any rate dips.
Beyond the mortgage market, home equity loans and unsecured credit products are well-positioned to benefit from increased clarity surrounding the pace of rate cuts expected in 2025. Debt consolidation remains a notable opportunity for lenders, particularly as many households continue to carry substantial debt burdens. Constrained housing inventory and the “lock-in effect” resulting from historically low first-mortgage rates have further exacerbated the situation. These conditions, coupled with rising home prices and total home equity nearing $35 trillion, provide meaningful tailwinds for lenders.
As the adage goes, “Do not fight the Fed.” While the journey to further rate cuts may be gradual, the longer-term outlook for lending remains positive. The key for lenders lies in offering the appropriate products to the right customers at opportune moments. A strategic approach, maintaining flexibility across all lending options, will allow institutions to effectively meet consumer needs in this dynamic environment.
Looking Ahead
As we go into the new year, uncertainties remain in the rate, growth and policy environments that we can’t fully predict. In addition to scenario planning across a range of rate scenarios, we therefore also recommend planning for scenarios that cover a wider range of competitive scenarios covering banks and new market entrants. For example, in a potential high–rate, high–growth scenario, banks will have to pull all their acquisition levers in concert (price, product, value proposition, marketing, distribution) to lock in the deposits that are required to fuel growth at costs that support profitability.
