Podcast Summary
Discrepancy between benchmark interest rates and APY on US bank accounts: Savers face extremely low yields on their savings, limiting their incentive to save and reducing monetary policy effectiveness.
The current interest rate environment is frustrating for both retail depositors and macroeconomic policymakers. While benchmark interest rates are increasing, the average annual percentage yield (APY) on US bank accounts remains extremely low at 0.23%. This discrepancy means that savers are not being incentivized to save more, which can limit the effectiveness of monetary policy. The low yields are also frustrating for savers who want their money to work for them. Despite this, there are options for those looking to earn higher yields, such as certificates of deposit or other investment vehicles. Joining us to discuss this topic further is Joe Abate, a money market strategist at Barclays. Abate's insights into fixed income research will provide valuable perspective on the current interest rate environment and its implications for both savers and policymakers.
Fed rate hikes don't guarantee deposit rate increases for savers: While the Fed raising interest rates may lead to higher deposit rates for savers, the degree and speed of the increase depends on banking industry competition and overdepositing
While the Federal Reserve raising interest rates may lead to increased deposit rates for savers, it's not an automatic process. Banks have significant pricing power when it comes to deposits due to the lack of substitutes offering the same level of protection, liquidity, and deposit insurance. The speed at which deposit rates rise depends on the competitive dynamics in the industry and the degree of overdepositing. Historically, the pass-through effect of the Fed's rate hikes into bank deposit rates has been around 30-40% over an entire cycle, but it starts low and increases as competition intensifies. This competitive dynamic allows banks to maintain some control over deposit rates despite changes in the Fed's policy.
Impact of QE and non-price competition on deposit rates: Quantitative Easing has led to larger cushions of deposits for banks, reducing the need to compete on interest rates. Non-price competition, such as services and integration with payment apps, is increasingly important and keeps deposits sticky.
Deposit betas, or the relationship between benchmark rates and what banks pay savers, have been trending lower in later interest rate cycles. This could be due to two main reasons: the impact of Quantitative Easing (QE) on deposit dynamics and the increasing importance of non-price competition, such as services and integration with payment apps. Banks have a larger cushion of deposits due to QE, which allows them to not compete as fiercely on interest rates as before. Additionally, banks increasingly compete on non-price factors like services and integration, making it less likely for customers to switch banks for a slightly higher interest rate. The hassle and time involved in switching banks, especially for institutional deposits, also plays a role in keeping deposits sticky.
Fintech checking accounts vs. traditional banks: While fintech checking accounts offer attractive interest rates, the hassle of dealing with them may outweigh the benefits for some. Deposit betas have declined due to large banks' concentration of deposits, convenience, stickiness, and network effects.
The interest rates offered by fintech companies on checking accounts may seem attractive, but the hassle of dealing with them can outweigh the benefits for some people. The decline in deposit betas over time could be related to the increasing concentration of deposits in large banks, which may be due to a combination of factors including convenience, stickiness, and network effects. Deposit rates are also influenced by the lending opportunities that banks see in the market, and banks balance the interest returns on their assets against the cost of raising more deposits or wholesale funding. Monetary policy plays a role in this dynamic by influencing the balance between asset growth and funding costs. As a leading real estate manager, Principal Asset Management provides local insights and global expertise to uncover compelling opportunities in the market, giving clients an exclusive advantage. The American Express Business Gold Card offers flexible spending capacity and annual statement credits for select business merchants, providing powerful backing for businesses.
The importance of retail deposits as a funding source for banks: Post-financial crisis, banks have shifted towards retail deposit funding due to increased regulatory emphasis on liquidity and stability, and the stickiness of retail deposits despite end of unlimited deposit insurance and rising interest rates.
The role of retail deposits as a source of funding for banks has become more important in the wake of the financial crisis and subsequent regulations. Before the crisis, banks increasingly relied on wholesale funding due to its availability and low cost. However, this made their funding vulnerable to interest rate changes and market instability. Post-crisis, regulators emphasized the need for banks to hold more liquidity and rely more on retail deposits. As a result, the use of short-term financial instruments like repo funding and CP market funding has declined, and deposit funding has become more prevalent. Despite the end of unlimited deposit insurance and rising interest rates, retail deposits have remained sticky for banks due to their ability to offer non-interest rate services. This shift towards deposit funding brings us back to an era where banks were more deposit-reliant and less reliant on financial products, reminiscent of the pre-interest rate decontrol era before 1980.
The distribution of deposits and bank reserves impacts banking competition: Post-QE, smaller banks face intense deposit competition due to larger institutions' deposit concentration, and QT exacerbates this trend by reducing available reserves and encouraging substitution effects
The distribution of deposits and bank reserves in the financial system, in addition to the overall level of these resources, plays a crucial role in the competitive landscape of banking. The aftermath of quantitative easing (QE) has led to a faster drain of deposits from smaller banks compared to larger ones, forcing smaller banks to offer more competitive deposit rates. This trend is due to the concentration of deposits in larger institutions during QE, leaving smaller banks with less liquidity to start with. As the Fed reduces its balance sheet through quantitative tightening (QT), the competition for deposits between large and small banks intensifies. It's essential to understand that QT doesn't just mechanically increase competition for deposits but also encourages substitution effects, allowing banks to replace deposits with other rate-sensitive assets like treasuries. The demand curve for bank reserves is a critical factor in this dynamic, as the reduction in the Fed's balance sheet shrinks the available reserves, making it more challenging for banks to meet regulatory requirements. Overall, this deposit competition is a lasting consequence of QE and its impact on the distribution of deposits and bank reserves.
Managing the Fed Funds Rate through Quantitative Tightening: The Fed manages interest rates through QT by controlling the supply of bank reserves, aiming for a balance between ample and not abundant, and avoiding steep or super flat demand curves.
The Federal Reserve's Quantitative Tightening (QT) process aims to create enough pressure on interest rates without causing excessive volatility. This is achieved by managing the supply of bank reserves to keep the Fed funds rate within its target band. The demand for bank reserves forms a concave-shaped curve, with significant changes in interest rates occurring in the steep slope of the curve. The Fed's goal is to keep the level of bank reserves ample but not abundant, avoiding both the steep and super flat parts of the demand curve. The exact amount the Fed will shrink its balance sheet is uncertain, but the ratio of reserve balances to total cash assets in banks is a more important indicator. When this ratio falls below 8%, bank reserves become scarce, and the Fed may need to intervene to prevent further rate increases.
Distribution of bank reserves between large and small banks: Small banks are closer to their 2019 reserve levels, while large banks still have room to build up their reserves. Money market funds, despite lower yields compared to bank deposits, are not experiencing significant inflows due to interest rate sensitivity and preference for prime money market funds.
While aggregate bank reserves may appear ample, the distribution between large and small banks raises questions about relative ampleness. Domestic banks still have room to build up their reserves, while small banks are closer to their 2019 levels. However, despite the difference in yields between bank deposits and money market funds, money market fund balances are not experiencing significant inflows. This may be due to interest rate sensitivity and the preference for higher yielding prime money market funds among retail investors, and institutional investors buying bills instead. It's unlikely that years of quantitative easing have completely suppressed interest rate sensitivity among investors. Instead, money is moving out of deposits and into higher yielding alternatives.
Changes in banking since 2008 financial crisis: Shop around for best deposit rates to earn more income and improve monetary policy mechanism, despite challenges of circular inflation cycle
The banking system has undergone significant changes since the 2008 financial crisis, leading to a premium on deposits and a sticky business model that makes it difficult for customers to switch banks. This, in turn, creates an uneven distribution of reserves and liquidity in the system. As quantitative tightening progresses, deposit rates may start to rise due to a substitution effect. Banking is not a monolith, and the complexities of the industry mean that it's not as simple as looking at one number to understand the situation. The network effect, which maintains dominance for entities like dollars, Twitter, and Facebook, also plays a role in keeping customers with their banks. The takeaway for individuals is to shop around for the best deposit rates to earn more income and improve the monetary policy mechanism. However, with the circular nature of prices and inflation, it may be a challenge for everyone to get out of the cycle of decreasing and increasing prices.
Bloomberg Launches New Podcast 'Money Stuff': Bloomberg introduces a new podcast, 'Money Stuff,' hosted by Matt Levine and Katie Greifeld, based on Levine's finance newsletter. Listeners can access it weekly on Apple Podcasts, Spotify, or wherever they get their podcasts. Odd Lots podcast offers additional content on their website, and American Express Business Gold Card sponsors the show.
Bloomberg is expanding its podcast lineup with the launch of a new show called "Money Stuff," hosted by Matt Levine and Katie Greifeld. This podcast is based on Levine's popular Wall Street finance newsletter, and it will air every Friday. Listeners can tune in on Apple Podcasts, Spotify, or wherever they get their podcasts. The Odd Lots podcast, hosted by Tracy Alloway and Joe Weisenthal, also mentioned that they have additional content available on their website, including blog posts, transcripts, and a weekly newsletter. The Odd Thoughts podcast is available on Bloomberg's podcasts page, and listeners can follow the hosts on Twitter. American Express Business Gold Card was also mentioned as a sponsor, offering benefits to help unlock more value from business purchases.
