Curinos Perspective: Liftoff! Fed Raises Rates

The Federal Open Markets Committee (FOMC) voted today to raise the target range for the Fed Funds rate from 0-25 basis points to 25-50 bp. This move was in line with the expectations of an overwhelming majority of market participants.

The world has changed a lot since the FOMC last met in January. There has been a dramatic improvement in the U.S. COVID-19 pandemic, the U.S. Bureau of Labor Statistics reported that the Consumer Price Index notched a 7.9% year-over-year jump (reflecting the highest increase since 1981) and crisis came to Ukraine. As we’ve said consistently in our publications, this cycle of rising rates will bring an unprecedented level of uncertainty.

Looking ahead, Fed Funds Futures markets still anticipate six or seven increases of 25 bp in the target Fed Funds rate by July.

In markets such as these, we’re humble about our crystal ball. The FOMC’s dual mandate is price stability and maximum sustainable employment. In the near term, the crisis in Ukraine and the corresponding international sanctions have roiled markets. This will produce upward pressure on inflation. In isolation this would suggest a higher year end range for the target Fed Funds rate. But the macroeconomic impacts of the crisis also have the potentially to impair global growth. This could have a moderating impact on the pace of increases to the target Fed Funds rate.

In short, the FOMC has a delicate balancing act to tame inflation without snuffing out economic growth against the backdrop of geopolitical and macroeconomic uncertainty. As the FOMC maneuvers to evade “stagflation,” we remind ourselves to expect the possibility of the unexpected.

Additionally, the FOMC said it expects to begin the process of reducing its balance sheet — the process known as quantitative tightening — “at a coming meeting.” While we would expect this to have limited impact in the near term, the pace and magnitude of quantitative tightening could potentially begin to affect bank funding conditions later in the year. This impact would likely be at least partially offset by the money multiplier effect. Therefore, a moderate pace of quantitative tightening would be unlikely to lead to a sudden outflow of surge liquidity at the system level. The result at the individual bank level will, however, vary based on the composition of the client base.

Commercial Deposits

Most banks are telling us that they expect low betas on the commercial portfolio after the first hike. Getting to this desired outcome, however, will require clear client-level plans, proactive communications with relationship managers and treasury salespeople and strong governance. Anecdotally, most banks we have spoken with began fielding a small number of exception rate requests a full week before the FOMC meeting. And, according to data from the most recent Curinos CDA Executive Summary, commercial liquidity product managers expect 2022 year-end betas to be similar with what we saw through the first year of the prior rising-rate cycle for interest bearing deposits and above what we saw that same period for ECRs. (See Figure 1.) How banks respond to the first hike will play an important role in setting expectations for future hikes.

Based on overall bank liquidity positions, it would be counterintuitive to see year end commercial deposit betas in line with or above what we saw in the prior cycle. And we believe this is inconsistent with the majority of CFO and analyst expectations. But, in our experience, executing a consistent plan tends to produce better through-the cycle results than frequently changing course on deposit appetite. The appropriate level of commercial deposit betas will vary from bank to bank based on loan growth output as well as composition of the deposits accumulated over the past two years. Specifically, it will depend how much growth is tied to primary relationships. With so many unknowns and little margin for error, it is critical that banks build their liquidity forecasts and beta plans down to the client level with consideration of customer primacy.

Figure 1: Expected Commercial Portfolio Betas in 2022

Source: Curinos CDA
Peter Serene
Director
peter.serene@curinos.com

An ARM Resurgence?

Mortgage lending has seen the dominance of 30-year or 15-year fixed-rate mortgages for decades, with adjustable-rate mortgages (ARMs) playing a minor role. That may soon change. Borrowers and home buyers have become accustomed to mortgage rates in the range of 2%-3%. With fixed rates now standing at 4.5% or higher and with the prospect of inflation pushing longer-term rates even higher, ARMs are poised for a reemergence. In fact, Curinos is already seeing growth in ARM product lending and a contraction in fixed-rate lending.

So how can lenders position themselves for this potential market shift? For banks and credit unions, it is crucial to understand the market “buy box” or risk parameters and determine how that relates to their own risk appetite. Additionally, insight and market intelligence into how to price for risk attributes (such as loan purpose, borrower credit, loan-to-value, etc.) is equally as important. 

Mortgage bankers who must sell loans (since they don’t have the ability to retain loans in their portfolio) need to develop relationships with banks and credit unions that have an ARM appetite. Of course, those relationships are best built when it isn’t a developing market for the loans. Otherwise, the mortgage bankers will find themselves in line with everyone else. After all, there are many regional banks and credit unions out there that would welcome strategic rather than transactional relationships.

John Sayre
VP Client Success
john.sayre@curinos.com

Consumer Deposits

Rising rates will come very welcome for consumer deposit books. With an excess of liquidity and declining fee revenue, we expect most market participants will be able to lag rates and see a much needed boost to margins. Though most banks are likely to lag the rate increase, it is important to note that not all will. It is therefore crucial for providers to obtain intelligence on the competition — even for those that have excess liquidity. Notably, credit unions didn’t drop rates as much as traditional banks through the downcycle and have already begun to increase rates, especially on longer-term CDs. (See Figure 2.)

Additionally, direct banks haven’t experienced the same deposit surge as traditional banks due to their smaller number of primary checking accounts. This has led to a decline in share of retail deposits held by direct banks for the first time in 20 years and may signal a greater appetite for growth. Already, we have seen many market participants raise rates on savings to 50 bp from 40 bp and longer-term CDs have increased 5 bp on average since December.

While rising rates will be welcome relief, banks must carefully track both external and internal data to ensure the relief can be enjoyed through the cycle. Externally, watch for new competitors, particularly in the digital space, and keep close watch on signs of increasingly aggressive market pricing. Internally, ensure that any deposit runoff doesn’t harm the franchise. Determine which customers are leaving, where they are going and whether they are taking relationships in addition to deposits. Careful and frequent monitoring will ensure that the wins can be durable. Winning banks will grow both margins and primary relationships through an uncertain and potentially challenging rising rate environment.

Figure 2: Credit Union and Direct Bank CD Rates Dec’21 – Feb’22

Average of CD rates

Source: Curinos Standard Rate Data, includes 66 internet banks
Adam Stockton
Director
adam.stockton@curinos.com

The Digital Response to Higher Rates

U.S.-based deposit account providers have fairly captive audiences because customers use banking apps to fulfill everyday financial needs. As higher rates trigger shopping behavior among rate-sensitive consumers, these providers must market personalized propositions. They must also be prepared to follow up with considered journey management and market-leading experiences.

In cross-selling to current customers, institutions must be proactive in pushing new products or updates in the right channels rather than putting out general messages through broad mediums. Sending an email to the entire customer base will no longer work; providers need to think about the channels where users are more likely to interact in app and online. Sophisticated providers already do that by promoting targeted product upgrades and cross-selling in their app’s secure customer areas.

While the payoffs are obvious, banks have historically been poor at communicating to customers that loyalty can be rewarded. It’s also important to avoid disrupting the customer’s intended journey — even if you are offering an alternative that may be worth the digression.

 

Progressive providers want their digital channels to be platforms that distribute products and services. The pace of digital prowess varies greatly, but a growing number are trying to cross-sell products and offer complete application journeys completely in the digital channel.

Checking account providers have become increasingly active in cross-promotions: of the 130 U.S.-based providers tracked by the Digital Banking Hub, nearly half (60) offer the ability to apply for credit cards in app, 47 offer personal loan applications, 44 provide auto loan submission facilities and 38 provide mortgage application capabilities.

As rates rise, propositions such as these made directly to engaged customers will pay off.

It should go without saying that firms must take stock of their digital onboarding capabilities by continually assessing the competitive landscape as they seek to secure new customers. Banks must remove platform friction to create value-generating interactions across all rate cycles. 

Michael McCaw
Digital Content Editor
michael.mccaw@curinos.com
Share via Email
Print
Share on LinkedIn
Share on Twitter

Be Inspired

Stay up to date on the latest trends and insights from Curinos

Want more insights?

Share your information to receive the latest and greatest content from Curinos.

Let's start a conversation...

Interested in learning more about Curinos and our solutions? Share your information and we’ll be in touch.