Capital Advisors Group published a research paper entitled, “Higher Deposit Rates – Where Art Thou?” The Abstract explains, “Bank deposits have not benefitted from recent fed funds rate increases. The absence of higher rates contrasts sharply with the yields on marketable securities and compares unfavorably with deposit rates seen in two previous Fed tightening cycles. Although prospects for higher deposit rates may improve soon, for now, liquidity investors should consider a portfolio approach that includes deposits and direct purchases, possibly through separately managed accounts.” We excerpt from this paper, and also review the ICI’s latest monthly “Money Market Fund Holdings”, below.
Capital Advisors’ Lance Pan writes, “Deposit relationships provide essential liquidity solutions for most treasury organizations. Several of our recent whitepapers have discussed the transformation of corporate deposits following significant regulatory changes in the banking and money market fund industries. Recent Federal Reserve data and industry surveys continue to support the popularity of deposits among institutional investors. On the other hand, depositors have not yet seemed to benefit from the Federal Reserve’s recent interest rate actions. While the yield on short-term marketable securities such as commercial paper (CP), has risen in tandem with the fed funds rate’s 1.00% increase since December 2015, deposit rates have not kept pace.”
He explains, “In this paper, we will compare deposit rates in the current interest rate environment with those of two previous Fed tightening cycles to demonstrate that, while deposits generally lag the market when rates are rising, this lagging effect is more pronounced today than in the past. We will discuss potential causes for this phenomenon and the potential timeframe for improvement in deposit rates. We will also offer our take on how institutional investors can best utilize deposits along with other short-term liquidity instruments in a portfolio approach.”
Pan tells us, “Bank accounts have been a main liquidity tool for as long as modern banking has existed. Beginning in the late 1990s, however, their popularity declined as investment in money market funds (MMFs) surged. This trend continued until the financial crisis of 2008 forced investors to reassess the latter’s resilience as stable liquidity vehicles during market tumults. Since then, as the Federal Reserve’s Flow of Funds report indicates, the combined savings and checking account balances have consistently accounted for nearly three quarters of the liquid balances at non-financial firms in the United States. Survey results from institutional liquidity investors confirm deposits’ popularity. A 2017 liquidity survey … by the Association for Financial Professionals found that 59% of the organizations’ short-term portfolios are allocated to bank deposits and Eurodollar deposits.”
He states, “It is safe to assume that institutional liquidity investors’ preference for deposits in recent years have not been driven by attractive yield opportunities as a sizeable portion of the cash has been in non-interest bearing transactional accounts. Also, banks have not been generous in handing out higher yield as the Fed continues with interest rate normalization…. From December 2015 through June 2017, the Federal Reserve has raised the short-term rates four times at 0.25% increments. Short-term market rates have climbed in response, but bank rates have yet to see meaningful increases.”
The CAG paper says, “A comparison to the two previous Fed tightening cycles (June 1999–May 2000 and June 2004–June 2006) indicates that banks today are comparatively less willing to pay up on deposits…. To conclude, despite the 1.00% total increase in the fed funds over the last 19 months, money market and short-term CD rates barely budged. Historically, these rates tended to rise with the fed funds rate, sometimes exceeding the benchmark rate increases. By contrast, short-term market rates rose along with FFR in all three periods by about the same magnitude.”
Finally, they tell us, “What has contributed to the low deposit rates seen in the current cycle? We can think of several possible causes, most of which trace back to the aftermath of the 2008 financial crisis: Abundant bank reserves …; Restrictive banking regulations …; Investor inertia after a long period of yield drought: After enduring nearly a decade of zero interest rates, some depositors may not have adjusted their expectations for higher income returns as the first few Fed hikes have occurred. They may become more demanding now that short-term benchmark rates are greater than 1.00%; and, MMF reform.”
In other news, the Investment Company Institute released its latest monthly “Money Market Fund Holdings” summary (with data as of July 31, 2017) yesterday. This release reviews the aggregate daily and weekly liquid assets, regional exposure, and maturities (WAM and WAL) for Prime and Government money market funds. The MMF Holdings release says, “The Investment Company Institute (ICI) reports that, as of the final Friday in July, prime money market funds held 29.2 percent of their portfolios in daily liquid assets and 42.7 percent in weekly liquid assets, while government money market funds held 56.5 percent of their portfolios in daily liquid assets and 75.4 percent in weekly liquid assets.” Prime DLA decreased from 29.6% last month and Prime WLA decreased from 43.9% last month. We review the ICI’s latest Holdings update, below.
ICI explains, “At the end of July, prime funds had a weighted average maturity (WAM) of 34 days and a weighted average life (WAL) of 74 days. Average WAMs and WALs are asset-weighted. Government money market funds had a WAM of 32 days and a WAL of 88 days.” Prime WAMs were up one day from the prior month, and WALs were up 2 days. Govt WAMs decreased by 2 days and WALs remained unchanged from last month.
Regarding Holdings By Region of Issuer, ICI’s release tells us, “Prime money market funds’ holdings attributable to the Americas declined from $179.16 billion in June to $174.32 billion in July. Government money market funds’ holdings attributable to the Americas declined from $1,761.29 billion in June to $1,686.38 billion in July.” (See too Crane Data’s August 10 News, “August Money Fund Portfolio Holdings: Repo Down, Treas, Agencies Up.”)
The Prime Money Market Funds by Region of Issuer table shows Americas-related holdings at $174.3 billion, or 41.7%; Asia and Pacific at $84.2 billion, or 20.2%; Europe at $157.0 billion, or 37.5%; and, Other (including Supranational) at $2.6 billion, or 0.7%. The Government Money Market Funds by Region of Issuer table shows Americas at $1.686 trillion, or 79.7%; Asia and Pacific at $99.6 billion, or 4.7%; and Europe at $327.6 billion, or 15.5%.
By: Peter Crane