While money funds are not strictly gauranteed or insured, the 85% invested heavily in government securities put up some stark competition for bank deposits that have lagged central bank policy rate rises over the past 18 months - causing much political ire in countries such as Britain. Savings deposit rates vary across the system between the near-zero rates at large banks still awash with deposits to slightly higher rates at small- and mid-sized banks now struggling to retain savings. But, in contrast to money funds, the average rate across all of them, according to the Federal Deposit Insurance Corporation, is still just 0.37%. And so, until this month at least, net interest margins at banks were still hugely padded despite the Fed's rate rise campaign because funding via deposits remained so cheap. That's now changing due to safety and insurance fears at smaller banks stateside - as well as the compelling alternative at money funds that appear safer against that backdrop.
Looked at another way, the near six-month-old inversion of the Treasury yield curve between three months and 10 years has been nowhere near inverted in the real world - if deposits were the main source of funding for long-term loans or mortgages.
And while the Fed has no interest in sowing systemic stress, the whole point of inverting the yield curve is to slow lending, the economy and inflation. And it will likely sit on this scenario until the real banking world responds. The upshot is the central bank may have to face down heightened expectations of interest rate cuts this year until lagging interest margins are finally squeezed, lending draws in and the economy slows durably enough to rein in inflation. "If the Fed is forced to hold rates higher for longer than the market is pricing, pressure on net interest margins will likely continue as banks have to keep paying up to retain deposits," William Blair Investment Management told clients. "The expansion in net interest margins that regional banks have enjoyed over the last several years is likely not to continue."
SLOWDOWN WITHOUT STRESS So can the Fed manage that process without the sort of contagion fears and emergency firefighting of the past month? One run through the numbers last week suggests the deposit problem at least may have further to go. JPMorgan strategist Nikolaos Panigirtzoglou and team estimated the most vulnerable banks likely lost around $1 trillion of deposits since the Fed started tightening early last year - as much as half of which happened after the Silicon Valley Bank crisis this month.
Of this trillion, half went to government money market funds and the other half to larger banks, they reckoned. Noting that some $7 trillion of U.S. bank deposits remained uninsured, the JPM team concluded: "A FDIC guarantee of all U.S. bank deposits would certainly help, but it might not be enough to completely stop this deposit shift." "Not only are money market funds offering superior yields, but they also look safer than bank uninsured deposits," they noted, adding the Fed's balance sheet run-down and related reduction of bank reserves was also likely affecting mid-sized banks most of all. That said, Glenmede chief investment officer Jason Pride thinks the shock is unlikely to be systemic. His argument is that SVB faced a peculiar combination of low levels of liquid capital and high share of uninsured deposits, which got cold feet about the balance sheet and the subsequent squeeze forced FDIC's intervention. But Glenmede said that of the top 42 publicly-traded FDIC-insured financial institutions, only seven banks shared similar characteristics of greater than 60% uninsured deposits and less than 80% liquid capital to deposit ratios.
"For now, since similar issues appear at only a relatively
narrow set of small banks, the risk of a systemic event in the
U.S. financial system appears contained."
GMO's asset allocation team concur and see shares in the
larger systemically-important U.S. banks at least as good value.
"Risks remain, but the banking sector will survive and some
banks will actually benefit from current stresses."
If that's true, the Fed may be minded to stay the course in
the fight to get inflation back to target.
Wariness of a destabilising credit crunch may hold them off
hiking again - but they may well welcome the shift in banking
calculus that comes with keeping rates elevated all year.
The opinions expressed here are those of the author, a columnist for Reuters. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ US money market fund assets soar US banks' net interest income vs US Yield Curve inversion ECB's euro zone and U.S. system stress monitor ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> (by Mike Dolan, Twitter: @reutersMikeD Editing by Emelia Sithole-Matarise)
Messaging: mike.dolan.reuters.com@thomsonreuters.net))