Banks, Boomers, and Bondholders
- Ryan Bunn
- Oct 5
- 3 min read
Lower interest rates will impact holders of US government debt — Banks, Boomers, and bondholders have the most to lose — Declining interest rates will pressure bank earnings, affluent US consumers, and the valuation of US bonds, equities, and dollars.
BANKS, BOOMERS, AND BONDHOLDERS
As the US Fed reduces rates, US government interest payments will fall. The US government is on pace to pay nearly $1.2 trillion in interest this year, over three times the interest bill from 2021.1 Reducing rates will reverse the trend of ballooning US government interest payments.
This anti-stimulus will hit three critical groups, each of which benefitted as interest rates rose. Banks, Boomers, and bondholders will see their interest income decline from the current run-rate of over $800 billion per year.2
While we do not expect to see a zero-interest-rate-policy (ZIRP) anytime soon, the market estimate of a ~3% Fed Funds rate by the end of 2026 would reduce these payments by 30%, or nearly $250 billion.3
Removing this liquidity from the economy will pressure bank earnings, affluent US consumers, and the valuation of US bonds, equities, and dollars.
Banks Don’t Need Your Money
Did you notice that despite interest rates rising above 4%, your savings account still paid no interest? There is so much liquidity in our financial markets that banks do not need deposits.
In a normal market environment, banks compete for deposits. Deposits are needed to fund the loans banks offer. Today, there is limited demand for loans and a corresponding apathy for deposits. With an excess supply of cash available, interest rates earned by consumers have not kept up with the Fed Funds rate.
But banks still earn this rate: in 2024, the Fed and US government paid banks over $200 billion in interest on reserve balances (IORB) and treasuries.4 In 2020 these payments barely exceeded $20 billion.
Since the end of 2020, US banks have seen their annual net interest income rise by $207 billion with over 90% of this growth being paid by the Fed or US government! Today, driven by these earnings, the KBW Bank Index is trading near all-time highs.5
How will banks fare as interest rates begin to fall?
Boomers & Savers
The US economy is currently bifurcated. The affluent consumer has been resilient while lower income groups have suffered. This is because the affluent consumer has savings, and these savings are suddenly producing interest income.
Households and the mutual funds they invest in hold almost $11 trillion in US debt. In the past year these savings have earned $330 billion of interest income. This stimulus has allowed savers to maintain their standards of living despite rampant inflation.
Boomers are the primary recipients of this massive stimulus. Retirees have built up investment portfolios over decades and, due to their age and income needs, often allocate more capital to bonds than equities.
This perfect combination of cash on hand and bond holdings went from earning no interest to over 4% in just a few years. What happens to the affluent savers when this stimulus slowly evaporates in 2026 and beyond?
An Infinite Loop
Foreign governments own $9 trillion of US debt. These entities are receiving more than $275 billion of interest annually. With this newfound income, these governments tend to reinvest in more US government bonds.
This dynamic creates an infinite loop, where higher US interest payments create more money that needs to be invested in US debt. As money moves through this loop, foreign bondholders must acquire US dollars to fund their reinvestment, supporting demand for the currency.
Even more aggressively, some foreign governments have been purchasing US equities with this interest income.6 This ties US interest payments directly to the performance of US equity markets.
This circular flow, when reversed, will have an equal and opposite effect, potentially impacting the US dollar and demand for both US debt and equities. Declining interest payments may actually reduce demand for US debt, increasing yields just as the Fed is trying to lower them.
Non-Conventional Wisdom
Believing lower interest rates will be a headwind to liquidity and a detriment to equity markets goes against conventional wisdom. After all, reduced interest rates are supposed to spur investment and support equity valuations.
Following the interest payments of the US government highlights the high performing segments of the economy that may have the most to lose. We see pressure coming for banks, affluent US consumers, and the valuations of both bonds and equities as interest rates head lower into 2026.
Sources:
4) Reference Equity Estimates (Fed IORB Payments, FDIC, Federal Reserve)
5) KBWB ETF
6) Swissinfo.ch