In a significant shift, Federal Reserve Chair Jerome Powell's indication of an upcoming policy adjustment has sparked a surge in investor confidence, particularly in US bank stocks. Market participants anticipate that lower interest rates will provide much-needed relief to struggling lenders, leading to a betting frenzy. As a result, an index tracking mid-size regional banks experienced a remarkable 5% surge on Friday - its largest single-day advance in all of 2024 - which held steady on Monday.

Powell's statement, "the time has come to adjust policy," reassured market players and set the stage for the first Federal Reserve interest rate cut in over four years. This development has buoyed the broader banking sector, with an index tracking the industry now up over 18% for the year, on par with the performance of the S&P 500. However, regional banks continue to lag behind, with the KBW regional bank index up just 6%.

Experts anticipate a catch-up trade for regional banks, with incremental rate cuts over the next six months potentially offering a much-needed boost to those struggling with credit quality. The possibility of lower interest rates has already led to a positive impact on a couple of regional banks heavily exposed to weakened commercial real estate borrowers. On Friday, New York Community Bank and Valley National Bank each experienced a 9% leap in their respective stock prices.

While interest rate cuts offer undeniable benefits to banks, the possibility of deeper or faster cuts raises concerns, particularly if the move is aimed at mitigating an economic downturn. An economic slowdown is deemed the worst outcome for banks at this point, according to market strategist Eric Wallerstein. The pace at which the Fed reduces rates will be key to banks' ability to adjust their balance sheets.

One advantage for many banks lies in the ability to lower the interest rates paid to depositors. Additionally, lower rates are anticipated to reduce the unrealized losses that regional lenders have on their bond portfolios, thus contributing to improved net interest margins. However, a potential drawback for banks emerges as yields from floating rate loans and bonds begin to decline, potentially pulling profit margins in the opposite direction.

Ebrahim Poonawala, a bank equities analyst with Bank of America Securities, suggests that while banks may experience some short-term negative impacts from asset repricing outpacing funding costs, the situation could be alleviated as loan demand picks up. This indicates that the timing and pace of rate cuts will significantly impact the overall outlook for banks.

Overall, the banking industry appears poised for a positive trajectory as the potential rate cut brings hope for improved performance. With regional banks in particular expected to benefit from the policy adjustment, market participants are optimistic about a potential catch-up trade. However, the resilience of banks in the face of economic challenges remains a key consideration moving forward.

David Hollerith, a senior reporter at Yahoo Finance covering banking and other financial areas, contributed to this report.