What’s Behind the Snail’s-Pace Increase in “Deposit Betas”?

If you’re a cash investor waiting for bank deposit yields to catch up with the Fed’s interest rate hikes, don’t hold your breath. The so-called “deposit beta,” which measures how fast banks raise their rates as a percentage of the increase in the federal funds rate, has risen at a snail’s pace compared to previous rate-tightening cycles. Since December 2015, the Fed has hiked rates six times at 0.25% increments. But while returns on short-term capital investments climbed in response, rates on bank deposits have yet to see the kinds of meaningful increases that were routine in the past. As of the first quarter of 2018, the average deposit beta at S&P 500 component banks was only 21%.

Our new research report, Deposit Betas Rising but Still Falling Short, explains why bank deposit yields have increased so slowly this time around, and why it may be a while before we see significant rate increases for deposits. The reasons range from higher cash reserves that banks have been required to maintain since the 2008 financial crisis, to a generation of corporate cash managers so accustomed to zero interest rates that they have been slow to demand higher returns on their deposits. Equally important, after money market fund reforms injected more risk into prime funds with the imposition of liquidity fees, redemption gates and floating net asset values, cash managers moved en masse to the traditional safe harbor of bank deposits. All of which lessened banks’ need for additional cash from depositors.

It’s a frustrating turn of events for institutional cash investors who like the ease and relative safety of deposits, but who don’t want to miss out on the long-awaited opportunity for higher returns. So, our report also offers alternative strategies that may provide an appropriate mix of liquidity, safety and yield. For instance, rates on short-term instruments such as commercial paper and repo have kept pace with the Fed’s rate increases. Market-based strategies such as direct purchases and separately managed accounts may be an answer for investors hoping to close the income gap between bank deposits and other short-term investments—especially as the Fed continues its steady march to higher interest rates.

For more on what’s behind the slow rise in bank deposit rates, and on what cash investors can do about it, download Deposit Betas Rising but Still Falling Short today.

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Best Regards,

Ben Campbell
CEO