KBRA Financial Intelligence

Fed Set to Shape Bank Profits With Rate and Economic Outlook

Long-Term Rates Fall, yet Yield Curve Steepens

Last week, the 10-year U.S. Treasury yield dipped below the 4% threshold for the first time in five months. Despite that decline, short-term yields have generally retreated even more quickly, steepening the yield curve. This steepening has been concentrated in spread between the 10-year and 2-year Treasury yields (T10Y2Y). Though the spread between the 10-year and 3-month yields (T10Y3M) has also steepened slightly, this shift has been more muted, with this portion of the yield curve continuing to struggle to emerge from inversion.

The shorter-term 3-month yield is more closely tied the Fed’s benchmark fed funds (also referred to as overnight) rate, which it has held steady throughout 2025. The divergence between the T10Y3M and T10Y2Y reflects the bond market front-running the Fed and pricing in its expectations of imminent rate cuts. KFI highlighted an even wider divergent pattern between the T10Y2Y and T10Y3M in September 2024, which preceded a 50-basis point (bp) rate cut in that month, and subsequent 25-bp cuts in November and December 2024.

The Fed again finds itself in a similar position to where it was this time last year. According to CME’s FedWatch tool, traders are only positioning for a 6% chance of a 50-bp cut this week, but a rate cut of identical size was seen as an outside probability last September as well. A more moderate 25-bp cut is currently seen as a 94% probability in CME’s data, while traders’ expectation of no rate cut is virtually zero. These odds have shifted rapidly amid the release of new and revised employment data, which has revealed an increasing degree of labor market weakness. As for traders’ expectations for the fed funds rate at the end of the year, the tool indicates a nearly 80% probability of at least 75 bps cuts through 2025’s final three Federal Open Market Committee (FOMC) meetings. That is up from just 43% on September 3.

A steepening of the yield curve carries significant implications for banks, whose lending profitability—as measured by metrics like net interest margin (NIM)—relies on their ability to fund long-term lending using deposits acquired at short-term rates. As KFI noted in our most recent Quarterly Banking Overview, a steadying of deposit costs amid continued growth in NIMs has allowed the average nontax equivalent NIM among U.S. banks to reach its highest level since 2019.

Fed Meeting to Impact Yield Trajectory

The degree to which short-term rates will continue to fall will largely depend on what action Fed policymakers take on Wednesday, as well as what kind of outlook they communicate for continued easing. KFI recently highlighted how the composition of the Fed’s Board of Governors might impact each of these variables, noting that two seats on the seven-member board hung in a state of limbo.

Each governor—along with four regional Fed bank presidents—partakes in the vote on what the fed funds rate should be set. Though the dust is not yet settled, it appears that Governor Lisa Cook will participate in the regular processes of the FOMC despite President Trump issuing a directive that she be removed from her post in August. That order has been blocked by a federal court for now, but it could soon be sent to the Supreme Court for further adjudication.

Meanwhile, Stephen Miran, nominated by President Trump to fill the spot vacated by the August resignation of former Governor Adriana Kugler, will also be seated on the board in time for September’s FOMC gathering. A vote on his nomination was fast-tracked for Monday, carrying the numbers to get Miran on the board quickly. This did not come as a major surprise, as KFI noted early this month that the nominee had easily secured Senate confirmation for his current cabinet post as chairman of the president’s Council of Economic Advisors, with a majority of 53 votes just six months ago.

While Miran’s presence may no longer may not be particularly consequential in terms of changes to rate policy at this week’s meeting, he could play a more material role in figures that will be included in the Fed’s latest Summary of Economic Projections (SEP). At four of the eight scheduled FOMC meetings in the calendar year, including September’s, Fed governors and presidents update the SEP by anonymously disclosing their individual outlook for inflation, economic growth, and the fed funds rate over the next several years. Medians for each of these variables are recorded in the SEP. The median expectation for rates forms the “projected appropriate policy path,” which is highly influential in financial markets.

KFI recently noted that, in addition to Miran likely becoming one of the more dovish members of the FOMC if his nomination is accepted by the Senate, he also expressed skepticism that tariffs have or will increase price pressures to the upside. That view is at odds with the direction that projections for inflation have been traveling in recent SEPs, suggesting Miran’s potential contribution might play a role in changing that trajectory.

Bank Loan Growth on the Rise

With GDP growth having bounced back from a small decline in 1Q 2025, currently projected by the Atlanta Fed’s latest GDP “nowcast” to exceed 3% for a second consecutive quarter, it is possible that the steady decline in long-term yields may be stemmed by a more robust economic expansion. Bank lending grew strongly in the first half of the year, with total loans extended by U.S. banks surpassing $13 trillion for the first time ever in 2Q 2025. Lending expanded at a rate of 2.1% QoQ—the fastest pace of bank loan growth recorded in three years.

Such conditions could create further yield curve steepening and a scenario where banks’ loan growth is expanding at a faster rate while NIMs continue to widen. The size of the spread between short- and long-term rates will depend on numerous factors, including how quickly the Fed will cut rates going forward, as well as inflation and GDP growth. In historical terms, the maximum difference between the 10-year yield and fed funds rate throughout the past six instances of monetary easing has ranged between 113 bps and 380 bps.