Bank stocks are comfortably in the green for 2024 — including a 1% bump in Thursday morning trading. But they have gained little ground in recent months amid lingering worries about fallout from high interest rates, including net interest margin pressure and cracks in credit quality.

The KBW Nasdaq Bank Index settled on Wednesday at a 107.3 reading, up about 11% year to date. But the index was ahead just 2% from the start of the second quarter. Banks also have trailed the broader market. The S&P 500 advanced nearly 19% this year through Wednesday.

The enduring strength of the U.S. job market, continued overall economic growth and rosy outlooks for rapidly advancing artificial intelligence technology bolstered bullish sentiment among investors across the stock market.

The S&P 500 “is off to its best start to the year since 2019 and the best start to an election year ever, driven by mega-cap tech stocks and artificial intelligence tailwinds,” said Raymond James Chief Investment Officer Larry Adam.

But sentiment in the banking space was relatively subdued by the sector’s outsize exposure to lofty interest rates and the specter of a higher-for-longer run through this year.

Julien Lafargue, chief market strategist at Barclays Private Bank, noted that the U.S. economy, while resilient, has eased this year — as has the pace of inflation — which could open the door for change.

“We expect to see continued, albeit slow, disinflation,” he said. This could pave a path for an interest rate cut as soon as September, he added, though that’s hardly a sure bet. When rates do reverse course, he said it is likely to be a gradual process that will leave borrowing costs high well into 2025. 

The Labor Department’s Consumer Price Index, released Thursday, showed that inflation eased by 0.1% from the previous month to a 3% pace in June. 

U.S. gross domestic product, the broadest measure of economic activity, slowed to an annual growth rate of 1.3% in the first quarter after advancing 3.4% in the final quarter of 2023, according to the Bureau of Economic Analysis. The Atlanta Federal Reserve’s updated estimate pegged second-quarter growth at 1.5%.

But the backdrop remains cloudy for banks: Interest rates surged in 2022 and last year — driven by Federal Reserve policy to tame soaring inflation in the pandemic’s wake.

The ongoing economic growth keeps inflationary pressure alive, and Fed policymakers are wary of rate reductions as a result. They signaled after a June meeting that at least one rate cut later this year is still in the cards, but that was far from the three or more reductions futures markets had anticipated entering this year.

The Fed lifted rates at the fastest pace in four decades between March 2022 and July 2023, to a range of 5.25% and 5.5%. It has kept its target rate at that level since.  

Elevated rates have driven up deposit costs for banks and, at the same time, slowed loan demand. That combination hurt banks’ profitability, as net interest income slumped.

Trepp analyst Emily Yue said interest income headwinds likely persisted in the second quarter, and she noted investors will get an early read Friday, when JPMorgan Chase, Wells Fargo and Citigroup report earnings. Bank of America follows early next week, rounding out the nation’s four largest lenders. They often prove bellwethers for the industry, including on the lending front for community banks.

Yue said her firm’s models projected a year-over-year decrease in earnings for the top four banks. Expected lower net interest income is “the main source of the negative shift in overall revenue growth,” she said.

Additionally, more banks reported increased credit losses over the past couple quarters. When borrowers with floating-rate loans such as credit cards see their debt costs jump, often more of them struggle to make their payments.

While most banks described credit woes as isolated and overall loan losses across the industry remain low, analysts say high rates deep into 2024 could spur more pain for borrowers. Inflation has been scaled back substantially from its 9% 2022 peak. However, at 3% it is well above the 2% rate that the Fed says is healthy. Some investors remain cautious in response.

“Bank stocks pulled back meaningfully in the second quarter versus the strength seen in the S&P,” Piper Sandler analysts Stephen Scouten and Matthew Clark said in a report. “This retrenchment comes as industry fears around credit have remained heightened and the pushing out of any expected rate cuts keeps generalist investors on the sidelines.”

Against that backdrop, earnings season may fail to produce new catalysts for investor interest. 

“It’s hard to argue a new theme or trend will miraculously emerge” during second quarter earnings, said Keefe, Bruyette & Woods analyst Christopher McGratty.