Warsh Fed will do nothing to derail rally in US bank shares

So far, 2026 has been the best of all possible worlds for US money centre bank shares and Wall Street brokers, a Panglossian season of peak profits and blowout capital markets revenue growth.

While software, memory and AI infrastructure stocks took a bungee jump on the Nasdaq in July, the major banks benefited from the SpaceX mega IPO, which generated a $500 million fee jackpot for the 18-member investment banking syndicate.

Both Goldman Sachs and Morgan Stanley, the two co-lead underwriters in the $86 billion deal – the largest IPO in the history of capitalism – enjoyed windfalls of $100 million apiece.

A Goldilocks economy with 2 percent GDP growth and stable consumer spending meant stellar corporate banking credit risks and loan growth metrics. The major banks have also been the beneficiaries of multi-billion dollars AI-related syndicated bank loans, public debt offerings and private placements needed to finance giant data centre campuses and nextgen power grids.

It is thus no surprise that the KBW Bank index – a benchmark stock index that tracks 24 prominent banking stocks – has been the second best-performing sector tracker in the US market over the past three months, while “Magnificent Seven” tech shares have stumbled on negative free cash flow and AI capex spending angst.

The KBW bank Index is now up 19 percent in the year to date and has easily outperformed the S&P 500 for the third successive year.

Is the bull run in US banking shares over? No. The KBW bank index trades at only 12.6 times earnings, well below its five-year historic valuation range of 13.2-13.4 times. Despite the US-Iran war and protracted Hormuz/Red Sea choke point crisis, bank earnings per share growth has accelerated in 2026.

What about interest rates? Kevin Warsh bungled his first two federal open market committee (FOMC) conclaves in June and July by refusing to discuss the central bank’s reaction function to shifts in economic data flow. Warsh’s failure to mollycoddle investors has led to a steeper US treasury bond yield curve. This has been bullish for US bank shares, which tend to benefit from a rising interest rate environment.
To be sure, the month-on-month rises in July consumer price index and producer price index were thankfully benign and reinforce Warsh’s conviction that there is no need for a pre-emptive interest rate hike at the September FOMC.

Warsh has also made it clear that Wall Street should not expect any forward guidance smoke signals from the Fed at the annual Jackson Hole central banker jamboree on August 29.

Yet the longer-term outlook is not so benign. The bond bears cannot ignore the fact that CPI is up 3.4 percent and the PPI is up a dismal 4.7 percent since July 2025 while the financial costs of the Iran War continue to escalate.

Tanker traffic in the Strait of Hormuz and the Red Sea is still vulnerable to Islamic Revolutionary Guard Corps, Iraqi militia and Houthi missile and drone attack. All is definitely not hunky-dory in the global debt market Xanadu.

Assuming the Warsh Fed does not raise the policy rate to 3.75 percent in September and treasury secretary Scott Bessent does everything possible to make sure that the Bank of Japan has access to Foreign and International Monetary Authorities repo funds – a mechanism that gives fast access to US dollars – when it needs to intervene in favour of the yen in the Tokyo foreign exchange markets, US short-term rates will not rise.

But the Uncle Sam IOU yield curve will steepen further – as investors demand more return for longer-term risk – if the bond vigilantes are spooked by another 9-3 dissent vote at next month’s FOMC.

The steepening of the US Treasury bond yield curve and the rise in the bellwether 10-year note yield from 3.94 percent on February 28 to 4.70 percent now cannot all be blamed on Warsh, as he only took the helm of the Federal Reserve in May.

The protracted nature of the Iran war, the Powell Fed’s failure to meet its 2 percent price stability dual mandate targets for five years in a row, the worst energy supply shock since the 1970s and a US budget deficit that is now an ominous 6 percent of $29 trillion GDP have all converged to raise real interest rates in the US as well as in the UK, Germany, France and Japan.

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It is rational to expect interest rate volatility to rise in September since the FOMC meeting coincides with rising geopolitical risk in the Gulf, Ukraine and even Brazil, where the socialist president Lula leads his centre-right rival in pre-election polls.

With Brent above $90, the 10-year US Treasury note at 4.70 percent and the Volatility index at a complacent 15, the bank rally could hit a temporary air pocket but its fundamental momentum is intact.