Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe. Wasn't all Joe? Do
Speaker 1: you know what the average interest rate paid on US
Speaker 1: bank accounts currently is? Holy? Because we just looked it
Speaker 1: up and I couldn't blow it. I actually thought you
Speaker 1: were wrong about as like I thought when you told
Speaker 1: me the number that you must be a despel point off. Yeah,
Speaker 1: it is surprising. So the average annual percentage yield er
Speaker 1: ap Y according to bank rate is point two three percent.
Speaker 1: And this at a time when, as you know, benchmark
Speaker 1: interest rates are at like four and a half four
Speaker 1: point seven five percent. I would have guessed that maybe
Speaker 1: they were like one and a half. Two percent was
Speaker 1: just still pretty low, right, So if you could get
Speaker 1: four and a half percent as a bank an overnight rate,
Speaker 1: and then it was like, okay, your saving your depositors,
Speaker 1: check your account whatever, you get a couple percent that's
Speaker 1: still spread, but they're still basically paying you nothing. I
Speaker 1: just want to like hold your cash there, which is
Speaker 1: pretty staggering. Absolutely, So this is a question that comes
Speaker 1: up a lot, and it's obviously frustrating. If you are
Speaker 1: a saver, you know, it's very everyone wants to be
Speaker 1: a rentier to some extent, right, I'll want to make
Speaker 1: money on our money exactly. That is the dream. So
Speaker 1: if the banks aren't passing through those interest rate hikes,
Speaker 1: it's naturally frustrating for retail depositors. However, it's also kind
Speaker 1: of frustrating from an economic slash macroeconomic policy perspective, because
Speaker 1: if you think about what monetary policy is supposed to do,
Speaker 1: it is supposed to work through changes in interest rates,
Speaker 1: which are supposed to ripple out from the central bank
Speaker 1: into the rest of the economy. Right intuitively, like one
Speaker 1: channel that you could imagine that rate hikes work through
Speaker 1: is oh, look suddenly I'm getting a lot more money,
Speaker 1: to say, or getting more Maybe I'll at the margin,
Speaker 1: I'll save a little more because I'm getting paid to
Speaker 1: spend a little less, create sort of decreased pressure in
Speaker 1: the economy. I don't know if anyone ever really thinks
Speaker 1: that way. It's like, oh, I'm not going to buy
Speaker 1: like this watch, or I'm not going to buy these
Speaker 1: like a concert tickets because I could get you know,
Speaker 1: three percent having left this money in the bank. Nonetheless,
Speaker 1: we have to get point two three percent. I'm definitely
Speaker 1: gonna okay, I'm definitely going to keep spending in that case.
Speaker 1: And of course there are ways to like get more
Speaker 1: yield and you could lock it up, but if you
Speaker 1: wanted to, you could go out, like buy a one
Speaker 1: year CICA of deposits. Wo's not going to do that,
Speaker 1: you know, You're not, Okay, it's so much to work. Okay, Well,
Speaker 1: this is clearly something that we need to talk about,
Speaker 1: both in the context of monetary policy and yes, broader economics.
Speaker 1: And I am very pleased to say that we really
Speaker 1: do have the perfect guest on this topic. We're going
Speaker 1: to be speaking with Joe Abote. He is a money
Speaker 1: market strategist over at Barclay's also does fixed income research.
Speaker 1: I've been a fan of his work for a very
Speaker 1: long time and happened meaning to get him on all
Speaker 1: thoughts for just as long. So I'm very pleased to
Speaker 1: have him here now to explain this discrepancy to us. Joe,
Speaker 1: welcome to the show. Thank you. Nice to hear. Yes
Speaker 1: and no. I think I think the fundamental problem with
Speaker 1: bank deposit rates is that there's so many different types
Speaker 1: of deposits, and because there's so many types of deposits,
Speaker 1: it's hard to kind of come up with one comparable
Speaker 1: interest rate across all banks and across all forms. Right,
Speaker 1: So you have deposits a time, deposits for example, CDs
Speaker 1: that you just mentioned, You've got checking account rates if
Speaker 1: they pay interest at all, and then you've got you know,
Speaker 1: different balance requirements for different types of customers and things
Speaker 1: like that. So coming up with an explicit, one size
Speaker 1: fits all bank deposit rate is difficult. But the phenomena
Speaker 1: that you're describing where bank deposit rates in a rising
Speaker 1: rate environment go up like a feather, and in a
Speaker 1: interest rate cutting environment where the Fed is easing policy,
Speaker 1: they sink like a stone. That's been a phenomena for decades. Well,
Speaker 1: let's get into that then. So you know the FED
Speaker 1: hikes rates on a Wednesday. Why doesn't that just automatically
Speaker 1: translate to a bunch of banks emailing savers and saying
Speaker 1: your deposit rate is going up? And I know there
Speaker 1: are a couple that do seem to automatically raise saving rates,
Speaker 1: but it's not the norm. Well, the question boils down
Speaker 1: to kind of what does the bank need right in
Speaker 1: terms of financing? Right, So most of its funding comes
Speaker 1: from deposits, and banks have a fair amount of pricing
Speaker 1: power when it comes to deposits, right, there's not many
Speaker 1: substitutes for bank deposits out You might try a money
Speaker 1: market fund, for example, or you might try, you know,
Speaker 1: bills or like some of the things that you were
Speaker 1: talking about, but you're not going to get the same
Speaker 1: level of liquidity, for example, with deposit insurance that you
Speaker 1: might with a bank deposit. And so if you're not
Speaker 1: faced with a lot of competition, and I'm talking about
Speaker 1: industry wide, then deposit rates don't necessarily have to go
Speaker 1: up lockstep with the increase in the fent funds rate.
Speaker 1: So to your point, you know, it's not terribly surprising
Speaker 1: that deposit rates don't go up immediately when the FED
Speaker 1: raises rates. Now, I will say that they do go up,
Speaker 1: and the real issue is not so much the level
Speaker 1: of rates, but the speed with which they go up, right,
Speaker 1: And that becomes a question of what people call the
Speaker 1: deposit data, which is how much of the monetary policy
Speaker 1: rate or the change in the FED funds rate actually
Speaker 1: gets passed on to depositors. And what happens is that
Speaker 1: initially in the tightening cycle, banks are over deposited, and
Speaker 1: as those deposits migrate into higher yielding products and they
Speaker 1: lose financing, they start to compete more aggressively with each
Speaker 1: other and they start to try to poach deposits from
Speaker 1: one institution to the next. And what you see is
Speaker 1: with subsequent rate heights, the deposit data right goes up.
Speaker 1: And so what you normally find is that in the
Speaker 1: last tightening cycle, for example, the pass through effect was
Speaker 1: only about thirty five to forty of the rate heights
Speaker 1: made it into bank deposit rates over the entire cycle.
Speaker 1: But if you started at the cycle, it was down
Speaker 1: around ten percent, and by the end of the cycle
Speaker 1: it was closer to seventy five or eighty percent. And
Speaker 1: that has happened, you know, pretty much every interest rate
Speaker 1: cycle going back decades, which is start low and high,
Speaker 1: but that the overall deposit beta for the cycle is
Speaker 1: somewhere around thirty to forty of the Fed's rate ings.
Speaker 1: And again, this is a competitive dynamic, right. There's not
Speaker 1: a lot of substitutes for deposits out there, right that
Speaker 1: offer the same level of deposit insurance or protection and liquidity.
Speaker 1: Then you know, banks have a significant degree of pricing
Speaker 1: power when it comes to deposits. So Joe, just on
Speaker 1: that note, this idea that eventually deposit rates do go
Speaker 1: up as the competitive process between banks kind of kicks in.
Speaker 1: One piece of interesting research that I saw from the
Speaker 1: New York Fed is this idea that deposit betas so
Speaker 1: the relationship between you know, benchmark rates and what banks
Speaker 1: are actually paying savers that they have been trending lower
Speaker 1: in later interest rate cycles. So the beta now is
Speaker 1: lower than it was in say like the early two
Speaker 1: thousands hiking cycle. It's lower than it was and sort
Speaker 1: of the most recent hiking cycle as well. What accounts
Speaker 1: for that? You know, if I had to spect you that,
Speaker 1: I'd say that there's probably two things that may account
Speaker 1: for it. One is that Kewey has kind of changed
Speaker 1: to the dynamics so that banks, you know, at the
Speaker 1: beginning of a tightening cycle are significantly more over deposited
Speaker 1: than they were in past tightening cycles. And that might
Speaker 1: account for why deposit betas are lower, because banks have
Speaker 1: a thicker cushion of deposits, and therefore they don't have
Speaker 1: to compete as readily as they did or as quickly
Speaker 1: as they did back in earlier tightening cycles. The second thing,
Speaker 1: which I think doesn't get as much attention right is
Speaker 1: the fact that I think banks increasingly, especially the larger
Speaker 1: domestic institutions, are not competing specifically on explicit interests. And
Speaker 1: I think what happens is that banks are able to
Speaker 1: pay people, especially institutions, with services, and rather than compete
Speaker 1: on interest rate, they compete on price services. So they
Speaker 1: may offer discounts, you know, volume discounts, if you want
Speaker 1: to think about it, and that that dynamic where you've
Speaker 1: got competition occurring through you know, kind of a non
Speaker 1: price mechanism, a non interest price mechanism, may alter how
Speaker 1: datas perform a tightening cycles. So I think that's probably
Speaker 1: I think those are probably the two main reasons why
Speaker 1: deposit datas are not as high as they were in
Speaker 1: previous cycles. So could factors like the quality of an
Speaker 1: online app, the size of the network, the ease of
Speaker 1: the website, the interconnectedness of a big banks website with
Speaker 1: payment apps like zell and other things like that, Like
Speaker 1: could Lease essentially be selling points where just bank X.
Speaker 1: I won't name any specific banks because I don't know
Speaker 1: the details. Bank excess look we have this great app,
Speaker 1: we have this great integration with all these things. Are
Speaker 1: you really going to move your you know, eight thousand
Speaker 1: dollars checking account over to why for one extra bank?
Speaker 1: Why for one extra percent? It's going to be like,
Speaker 1: you know, fifteen dollars extra a year and all the
Speaker 1: has to details. Yes, I think that. I think that's
Speaker 1: exactly right. I would also say that there's a time
Speaker 1: tax involved too, right, which is kind of the corollary
Speaker 1: of this, which is that your paycheck is linked directly
Speaker 1: to your checking account and you know, migrating it to
Speaker 1: a different bank requires you know, kind of contacting HR
Speaker 1: or probably filling out online forms at your office to
Speaker 1: kind of change the direction. And that's a hassle. And
Speaker 1: I think the hassle effect is probably what keeps deposits sticky,
Speaker 1: as well as the service effect that you mentioned, right,
Speaker 1: the non non price services. I would suspect that the
Speaker 1: effect is actually bigger for institutional deposits than it is
Speaker 1: for retail depositors. Right, that institutions obviously face much bigger
Speaker 1: costs switching banks. In addition to other non price services,
Speaker 1: which might include investment banking advice or things along that nature.
Speaker 1: That make deposits a little bit more sticky at the
Speaker 1: institutional level as well as it's a retail level, so
Speaker 1: it's not just retail but also institutions. Right, if you're
Speaker 1: a treasurer for a large company, I can imagine that
Speaker 1: there's a whole process to changing your preferred bank. Right.
Speaker 1: You know, Tracy and our producer Dash, I'm not going
Speaker 1: to say which one, but they're both customers of a
Speaker 1: certain large banks fintech arm and they're also talking about
Speaker 1: always talking about like the juicy interest rates they're getting
Speaker 1: on their checking accounts. But it does seem like kind
Speaker 1: of a hosshold. So yes, it is more money, but
Speaker 1: I don't really want to deal with it. What you know,
Speaker 1: when we talk about competition, what about sort of like
Speaker 1: classical ideas about market structure in terms of the number
Speaker 1: of banks, the size of the banks, the rise of
Speaker 1: like a handful of these mega national banks, and does
Speaker 1: that play and you roll in the sort of decline
Speaker 1: and deposit betas over time. You know, I'm not an
Speaker 1: industry analyst at that level. You know, we do have
Speaker 1: a lot of banks in the US, and there is
Speaker 1: definitely a convenience factor to location. So hard to know
Speaker 1: how that plays out, at least in my mind in
Speaker 1: terms of deposit concentration. But deposits are definitely concentrated in
Speaker 1: the US at the largest banks. I will say that
Speaker 1: now again, is that because of the stickiness of those banks,
Speaker 1: or the convenience or their online services or their network effects.
Speaker 1: I suspect it's a variety of everything. So one thing
Speaker 1: I wanted to ask is, you know, the way sort
Speaker 1: of retail deposits are supposed to work is you give
Speaker 1: the bank money, they pay you some interest, and the
Speaker 1: interest is coming from I guess the array of central
Speaker 1: bank facilities nowadays, but also from the bank taking your
Speaker 1: money and lending it out into the wider economy. So
Speaker 1: to what degree our bank deposit rates also a function
Speaker 1: of the lending or investment opportunities that banks see in
Speaker 1: the market. The primary driver is going to be asset
Speaker 1: growth on the bank side, right, That determines how competitive
Speaker 1: banks have to be in deposits. And so if you
Speaker 1: think about the bank's balance sheet on the asset side,
Speaker 1: it's got essentially three types of assets. It's got loans,
Speaker 1: it's got cash that it has to maintain for regulatory purposes.
Speaker 1: At the few reserve and it's got securities holdings. Right
Speaker 1: on the liability side, most of its funding comes in
Speaker 1: the form of deposits of some kind, and there's an
Speaker 1: advantage to deposits, especially retail deposits, because as you said,
Speaker 1: they are pretty sticky, right, and the stickiness is partly
Speaker 1: a function of the services, but it's also a function
Speaker 1: of government guaranteed deposit insurance as well. In addition to that,
Speaker 1: there's wholesale funding that they can rely on. Now, whether
Speaker 1: that's commercial paper or turned financing, corporate debt, etc. These
Speaker 1: are all supplemental forms of funding that they can rely
Speaker 1: on to camp up their funding as asset growth, you know,
Speaker 1: as assets growth, and so from banks perspective, it's got
Speaker 1: to figure out and it's got to balance on the
Speaker 1: asset side the interest returns on its earning versus interest
Speaker 1: costs of raising more deposits are raising more wholesale funding,
Speaker 1: and that balancing act is really blue way Monetary policy
Speaker 1: is expected to unfold, right, Monetary policy is expected to
Speaker 1: kind of influence that dynamic. The asset side of the
Speaker 1: balance sheet determines how you decide to fund it, whether
Speaker 1: you're using deposits, which are probably the cheapest, stickiest form
Speaker 1: of funding, or whether you're using wholesale funding right, which
Speaker 1: is a little bit more expensive, more flight prone, but
Speaker 1: you know, depending on your size, may be easier to
Speaker 1: raise because you have more market access than say a
Speaker 1: smaller institution. So it becomes kind of a question of
Speaker 1: at least monetary policy becomes a question of how to
Speaker 1: banks triage between their asset growth deposit the loans securities
Speaker 1: in cash versus their liability side deposits and wholesale funding
Speaker 1: for its commercial paper, corporate bonds, other you know, kind
Speaker 1: of term financing that's available out there, and that kind
Speaker 1: of balancing is the way monetary policy is supposed to
Speaker 1: affect bank lending decisions and the transmission of the Fed's
Speaker 1: interest rate changes. Can you talk a little bit more
Speaker 1: about how retail deposits as a source of funding, their
Speaker 1: role in twenty twenty three or twenty twenty two or
Speaker 1: whatever versus the past, What is the like how would
Speaker 1: you know if we're having this conversation in the nineties
Speaker 1: or early two thousands, what is the role of retail
Speaker 1: deposits as a source of funding then versus today? Has
Speaker 1: it changed? Yeah? So what I would say is that
Speaker 1: retail deposits have actually become more important over time because
Speaker 1: of regulatory changes. So if you're called back before the
Speaker 1: financial crisis, one of the things that was happening was
Speaker 1: that banks were increasingly reliant on wholesale funding. And they
Speaker 1: went to wholesale funding because it was cheap and it
Speaker 1: was readily available. But the result of that wholesale funding
Speaker 1: reliance was that a lot of their funding became very
Speaker 1: very rate sensitive and very rate or rather very flight prone.
Speaker 1: And you can imagine an extreme situation where you're financing
Speaker 1: let's say, thirty year mortgages and you're financing them on
Speaker 1: an overnight basis in the repo market, you have a
Speaker 1: significant maturity mismatch, right where if that repo funding can't
Speaker 1: be rolled, you lose your source of financing for those mortgages.
Speaker 1: And so one of the consequences of the financial crisis
Speaker 1: when we aw that funding was as light prone as
Speaker 1: it was, particularly in these markets, regulators kind of emphasize
Speaker 1: the need for banks to a hold more liquidity, whether
Speaker 1: it's told higher cash balances at the FED right and
Speaker 1: simultaneously rely more heavily on wholesale funding on retail funding,
Speaker 1: that is deposit based funding. And so we've seen over
Speaker 1: the last really twenty years or so as a decline
Speaker 1: in the ratio of repo funding CP market funding, you know,
Speaker 1: kind of these financial instruments of short maturities and we're
Speaker 1: financing asset growth, you know, before two thousand and six,
Speaker 1: and those have been replaced by more deposit funding now.
Speaker 1: As I said earlier, initially that would be reflected in
Speaker 1: higher deposit rates. Of course, que at the time at
Speaker 1: suppress deposit rates. And if you recall that before twenty
Speaker 1: and twelve, right, we had unlimited deposit insurance on transaction
Speaker 1: fought accounts for a while, right, in order to kind
Speaker 1: of keep funding stable for banks. What's happened since then, right,
Speaker 1: as as interest rates go up, as I said earlier,
Speaker 1: banks have been able to compete on non price or
Speaker 1: non interest rate services more and the deposits have kind
Speaker 1: of remained sticky. So you have this kind of wholesale
Speaker 1: shift away from kind of wholesale funding to retail deposits.
Speaker 1: And if you want to go back even further, this
Speaker 1: looks more akin to an environment that kind of existed,
Speaker 1: you know, prior to the nineteen eighties, right, to an
Speaker 1: environment where banks were much more deposit reliant and much
Speaker 1: less relying on financial products. And if you look back,
Speaker 1: you know further, this is kind of really beckons to
Speaker 1: an era of you know, kind of pre interest rate
Speaker 1: decontrol for nineteen eighty. But again that's that's going back
Speaker 1: a lot of many, many many years now, right, So,
Speaker 1: depot sets are more important as a source of bank
Speaker 1: funding thanks to the experience of the financial crisis and
Speaker 1: post GFC regulation, and at the same time, because we've
Speaker 1: had things like que a lot of banks are simply
Speaker 1: swimming in deposits to the extent that they kind of
Speaker 1: have more than they perhaps need, which means that they
Speaker 1: are willing to allow depositors to maybe look elsewhere for
Speaker 1: better rates. They are However, some banks are losing deposits
Speaker 1: faster than other banks. Yes, I wanted you to bring
Speaker 1: this up. This is the small bank versus large bank
Speaker 1: deposit experience. And also this dovetails with a previous episode
Speaker 1: on discount lending, the discount window. I'm sorry I missed
Speaker 1: that discount window lending piece, but I think you're exactly
Speaker 1: right here, which is that the level of deposits and
Speaker 1: the level of bank reserves in the system. That is,
Speaker 1: the cash and the liquidity circulating in the system is important,
Speaker 1: but so too is the distribution of those balances across institutions.
Speaker 1: And what we're seeing is that unlike QT or quantitative
Speaker 1: tightening in twenty seventeen, the deposits are leaving right, or
Speaker 1: at least the cash is leaving small banks faster than
Speaker 1: it's leaving the large banks, and so that the smaller
Speaker 1: banks are forced to compete more aggressively in deposit markets
Speaker 1: than say they're larger banks. Now, part of this is
Speaker 1: a reflection of the fact that when QT occurred, right,
Speaker 1: deposit balance is migrated to the largest institutions out there,
Speaker 1: again because deposits are heavily concentrated, and so those banks
Speaker 1: tended to be more over deposited relatively speaking than the
Speaker 1: smaller institutions. That when the FED is braining reserves and
Speaker 1: shrinking its balance sheet, the people that have less liquidity
Speaker 1: to start off with because they had less fewer deposits,
Speaker 1: those are the institutions that are experiencing more deposit rate pressure.
Speaker 1: How do the small banks even compete? I mean, I
Speaker 1: guess rods as you say, but like, is this like
Speaker 1: going to be a permanent condition of banking. This struggle
Speaker 1: that the small banks have for deposits relative to these high,
Speaker 1: high networked large national banks. Again, you know, small banks
Speaker 1: would argue that there are you know, advantages to banking locally,
Speaker 1: and that the advantages to banking locally is, you know,
Speaker 1: your mortgage lender knows the market right, knows the housing
Speaker 1: market in your area, your commercial banker knows your business,
Speaker 1: knows your knows you personally, etc. And so there's you know,
Speaker 1: So I wouldn't say that it's inevitable that all deposits
Speaker 1: will migrate to large institutions, and large institutions will be
Speaker 1: selective and paying deposit rates. I still think that there's
Speaker 1: enough competition between large and small banks right that you know,
Speaker 1: small banks are not going away at all. But again,
Speaker 1: this deposit competition that we're experiencing right now is the
Speaker 1: aftershock of quantitative easing, right. Quantitative easing and the buying
Speaker 1: of treasury securities and mortgages again ended up putting a
Speaker 1: lot of deposits into the system as a whole. But
Speaker 1: those deposits tended to pile up faster at the larger
Speaker 1: institutions than the smaller institutions. So just on that note,
Speaker 1: and you already touched on this, but can you dig
Speaker 1: in a little bit more into what QT or quantitative
Speaker 1: tightening actually means for I guess the effectiveness of monetary
Speaker 1: policy is it does it like mechanically ramp up that
Speaker 1: competition for depositors, or does it maybe encourage some sort
Speaker 1: of substitution effect where you know, banks can I don't know,
Speaker 1: replace bank deposits with great sensitive treasuries or something like that.
Speaker 1: That's again an important distinction, and I think what you
Speaker 1: have to look at here is the demand curve or
Speaker 1: bank reserves, right. This is the liquidity that's in the system,
Speaker 1: created from quee right from the asset side of the
Speaker 1: fed's balance sheet, and these reserves are used to me
Speaker 1: int day requirements for settling payments as well as liquidity
Speaker 1: requirements for regulatory purposes that banks are required to maintain.
Speaker 1: And as the FED lets the assets on its balance
Speaker 1: sheet roll off right and doesn't replace them, so that
Speaker 1: it's balance sheet shrinks, bank reserves go down, right, and
Speaker 1: the decline in bank reserves is what forces banks right
Speaker 1: ultimately to compete more aggressively in deposit markets because they
Speaker 1: need to restore that cash position on their balance sheet.
Speaker 1: In addition to the fact that their assets growing, right,
Speaker 1: they're making loans, they need to replace that funding. The
Speaker 1: extent to which QT creates reserve pressure, right, is what
Speaker 1: creates the pressure on the FED funds rate. Right, the
Speaker 1: Fed's policy instrument and determines ultimately where the FED funds
Speaker 1: rate trades within its target band. Right. So what the
Speaker 1: FED wants to do is, if you think about the
Speaker 1: demand curve, demand curve is probably for bank reserves is
Speaker 1: probably I'm going to get this wrong concave shape, right,
Speaker 1: so it kind of caves in in the middle, and
Speaker 1: when you get to the upper part of the demand curve, right,
Speaker 1: you're in the steep slope. The steep slope of that
Speaker 1: demand curve means is that changes in the level of
Speaker 1: bank reserves creates significant changes in interest rates. And the goal,
Speaker 1: right from the Fed's perspective, is merely to shift the
Speaker 1: supply of bank reserves so that it's in the gently
Speaker 1: sloping part of the demand curve. Right, that the level
Speaker 1: of bank reserves is ample, right, but not abundant. An
Speaker 1: ample means that it's not scarce, right, so that the
Speaker 1: level of the Fed funds are a relative to other
Speaker 1: market rates or within the band. Right, it's comfortably in
Speaker 1: the middle. Right. Remember, the Fed is is targeting a
Speaker 1: twenty five bases point band between the top and the
Speaker 1: bottom of the Fed funds rate, and the goal is
Speaker 1: to kind of keep the Fed funds rate, you know,
Speaker 1: within the midpoint, let's say, of that band, right or
Speaker 1: close to that midpoint. So again, you want to stay
Speaker 1: away from the steep part of the demand curve. But
Speaker 1: it's the same respect right, unless you're you know, substantial
Speaker 1: easing policy and you've pushed rates to zero. You also
Speaker 1: want to stay away from the super platform of the
Speaker 1: demander right where you've got bank reserves and access. At
Speaker 1: four trillion dollars, interest rates are totally unresponsive to the
Speaker 1: level of liquidity in the system because you've effectively driven
Speaker 1: rates to zero. Right. So again that's that's kind of
Speaker 1: a long winded way of describing what the goal of
Speaker 1: QT is, Right, create enough pressure on interest rates but
Speaker 1: not too much. How do you have an estimate for
Speaker 1: how small the fit is going to shrink its balanchid ultimately? So, uh,
Speaker 1: this is pretty complicated, and I think you have to
Speaker 1: be pretty humble, we should ask what the level of
Speaker 1: ample excess reserves is too, just to get all the
Speaker 1: all the loaded questions out there, all right, So my
Speaker 1: sense is that the level of ample reserves is probably
Speaker 1: around two point seven trillion dollars. But I'm a little
Speaker 1: bit cautious about that because I think the level of
Speaker 1: reserves is less important than the ratio of reserve balances
Speaker 1: is to the total cash total assets that banks have.
Speaker 1: So that if you look at twenty nineteen, when we
Speaker 1: saw all that bank reserves got too thin, we saw
Speaker 1: that going back to our demand curve, right, the ratio
Speaker 1: of bank cash assets to total assets strength below eight percent.
Speaker 1: So the eight percent mark is kind of the threshold
Speaker 1: that divides ample from scares, and so my senses, you
Speaker 1: want to keep bank reserves in terms of ample around
Speaker 1: eight percent or higher. Right at the moment, they're around
Speaker 1: nine percent. If you break that number down between domestic
Speaker 1: banks and small banks, right, you see a very different picture. Right,
Speaker 1: domestic banks, that ratio is around ten and a half percent,
Speaker 1: and they're probably still two percentage points or more away
Speaker 1: from that twenty nineteen level where they were scarce. If
Speaker 1: you look at small banks, they're around six percent sense,
Speaker 1: and that's much closer to where they were in twenty nineteen.
Speaker 1: So as we were talking about before, you know ample, right,
Speaker 1: in an aggregate sense, you would definitely say that bank
Speaker 1: reserves are ample, But in a relative sense, in terms
Speaker 1: of the distribution between large and small banks, it's not
Speaker 1: clear that there's as much ampleness of bank reserves than
Speaker 1: the numbers suggest. I just have one more question, which is,
Speaker 1: you know, in the interests of I guess, both financial
Speaker 1: stability and the effective transmission of monetary policy and fighting inflation,
Speaker 1: should we all be going out and finding the best
Speaker 1: deposit deals for ourselves. Should we all be moving our
Speaker 1: money around? Is this helpful? Yeah? I mean everybody wants
Speaker 1: to earn more money, so I would expect that people
Speaker 1: would migrate their balances to hire yielding products. And the
Speaker 1: closest substitute for bank deposit at this point is a
Speaker 1: money market fund. And the curious thing is that money
Speaker 1: market funds are not experiencing inflows, right, So money market
Speaker 1: fund balances are paying about four percent or more in
Speaker 1: terms of seven day yields, right, So you can definitely
Speaker 1: earn more than the twenty three basis points you mentioned
Speaker 1: right in a government only money market fund. And what's puzzling,
Speaker 1: at least to me, is that, given that difference between
Speaker 1: what you can earn a money market fund and a
Speaker 1: bank deposit, right, why aren't money fund balances going up? Right?
Speaker 1: Why aren't they significantly higher than they are right now?
Speaker 1: And I suspect right that there are two reasons for this, right.
Speaker 1: One is that on the retail side, we are seeing
Speaker 1: some level of interest rate sensitivity, but people are moving
Speaker 1: into higher yielding products than government only money market funds.
Speaker 1: And in fact, what they're doing is they're moving into
Speaker 1: prime money market funds. And the prime money market funds
Speaker 1: won't go into this sort of the details, but they
Speaker 1: buy commercial paper and other credit instruments right, all short maturity,
Speaker 1: but they earn a little bit more than a government
Speaker 1: only money market fund. And so if you're an interest
Speaker 1: rate since it's investor right, and you're looking for higher yields,
Speaker 1: you're going to migrate into the prime funds. And what
Speaker 1: we've seen is prime fund balances have gone up sharply
Speaker 1: in the last at least since lift off. When you
Speaker 1: look at institutional investors, I think what institutional investors are
Speaker 1: doing is they're buying bills, right, They're looking at bill
Speaker 1: yields and saying bill yields are significantly higher than what
Speaker 1: I can get on a money market fund, right, And
Speaker 1: so I'm going to buy bills rather than invest in
Speaker 1: money market fund because I can earn higher yews. What
Speaker 1: I do not think is true is that I do
Speaker 1: not believe that multiple years of quantitative easing have somehow
Speaker 1: suppressed interest rate sensitivity among investors so that they no
Speaker 1: longer care about four percent yields in money market funds
Speaker 1: and it will be happy to earn twenty three basis
Speaker 1: points in a bank deposit and not move I suspect.
Speaker 1: And we are seeing this as money is coming out
Speaker 1: of deposits, but it's migrating into higher yielding stuff and
Speaker 1: not necessarily governmental in money market funds at least for now. Okay, Joe,
Speaker 1: that was a fantastic explanation of how this all works.
Speaker 1: Thank you so much for coming on all lots. You
Speaker 1: fulfilled a long held dream of mine to get you
Speaker 1: on the show. So thank you so much. All right,
Speaker 1: thank you. By now, so, Joe, I thought that was
Speaker 1: not just an interesting walk through the question at hand,
Speaker 1: which is why aren't banks raising deposit rates? But also
Speaker 1: kind of a really nice overview of how the monetary
Speaker 1: policy interaction with the financial system has actually changed since
Speaker 1: the two thousand and eight financial crisis. No, I mean
Speaker 1: I was like really interesting, like that sort of headline question,
Speaker 1: why why don't they raise rates? But also like I
Speaker 1: was just sort of curious, like how do banks work?
Speaker 1: You know, like what is seriously like what is the
Speaker 1: role of deposits? No, now you're like, why isn't more
Speaker 1: money flowing into government money market funds? Well? Yeah, I
Speaker 1: mean seriously, but I mean all these things like over time,
Speaker 1: like the policy changes that were made, you know, post grant,
Speaker 1: post grade financial crisis that sort of put this premium
Speaker 1: on deposits. You know, there's this stat that I have
Speaker 1: seen and heard that like you're more likely to get
Speaker 1: divorced than to ever change banks in your life. Yeah,
Speaker 1: and so what I've heard, and I don't know if
Speaker 1: it's true. Other you know who knows is our frequent
Speaker 1: guest Patrick McKenzie has written about this. But why do
Speaker 1: banks still have these physical Yeah? Because if they could
Speaker 1: just I've heard that if they could just get like
Speaker 1: a few people in the door you're worth so much
Speaker 1: money over the course of the lifetime as a customer,
Speaker 1: even though no one goes into those retail things. And
Speaker 1: it's partly because no one never really switched at banks.
Speaker 1: I think it is like a phenomenally sticky business model.
Speaker 1: And I remember when I went to university in London.
Speaker 1: I remember banks pitching these student programs, and if I
Speaker 1: was still in London, I think I would still be
Speaker 1: with the bank that like recruited me when I was
Speaker 1: a college student. It's weird because I think, like intuitively,
Speaker 1: you'd think with the Internet that look that moving money
Speaker 1: from one of to another would be more liquid, yeah,
Speaker 1: more easy, But somehow it seems like the opposite, because
Speaker 1: you have all these apps and you have passwords, and
Speaker 1: you have bills connected to your account, and so I
Speaker 1: feel like I'm going to change your banks, Like that's
Speaker 1: so many things to switch, it's just not worth it.
Speaker 1: The network effect, Yeah, the same thing that dollar dominance
Speaker 1: and Twitter dominance and Facebook dominance. Even though it's all
Speaker 1: it's it's network effects all the way down. So the
Speaker 1: two other things I thought were really interesting, just very quickly,
Speaker 1: are that idea of reserve scarcity, and this is something
Speaker 1: that came up with Bill Nelson when we were talking
Speaker 1: about why have we seen this tick up in discount
Speaker 1: lending to the banks. This idea that even though we
Speaker 1: still have a lot of reserves and liquidity in the system,
Speaker 1: they are not evenly distributed. Yeah. And then secondly this
Speaker 1: idea that as quantitative tightening really kicks into gear, you
Speaker 1: might start to get this process where deposit rates start
Speaker 1: going higher and there is that substitution effect. Yeah, and
Speaker 1: the fact that like you can't actually or you're the
Speaker 1: you're only gonna go get so far taking a crude
Speaker 1: measure of cash to total assets. Because of this very
Speaker 1: difference and model between the big domestic banks and the
Speaker 1: small banks and how they make the smaller banks might
Speaker 1: run into liquidity scarcity a lot faster than the larger banks.
Speaker 1: So you know, can see why analysts like Joe are
Speaker 1: in demand because it's not as simple as just sort
Speaker 1: of like looking at one number and dividing by another number. Totally,
Speaker 1: banking is not a monolith. Also, everyone should go deposit
Speaker 1: rate shopping in order to aimate more money and improve
Speaker 1: the monetary policy mechanism worse inflation. Will all be getting
Speaker 1: more income and more income, the last thing that we
Speaker 1: all need right now. If I had, if I was
Speaker 1: a fintech, you guys are, and I'd be spending that money. Okay,
Speaker 1: we're back to the circular nature of like prices going
Speaker 1: down and then increasing prices, and then we never get
Speaker 1: out of it. Shall we leave it there? Let's leave
Speaker 1: it there. This has been another episode of the All
Speaker 1: Thoughts Past. I'm Tracy Alloway. You can follow me on
Speaker 1: Twitter at Tracy Alloway and I'm Joe Why isn't thall?
Speaker 1: You could follow me on Twitter at the Stalwart, follow
Speaker 1: our producers Kerman Rodriguez at Kerman Ermine and Dash Bennett
Speaker 1: at dashbot, and check out all of our podcasts here
Speaker 1: at Bloomberg into the handle at podcasts, and for more
Speaker 1: Odd Lots content, go to Bloomberg dot com slash odd Lots,
Speaker 1: where we blog, we post transcripts. We have a weekly
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Speaker 1: Thanks for listening.