The Federal Open Markets Committee (FOMC) voted today to raise the target range for the Fed Funds rate by 50 bp from 25-50 bp to 75-100 bp. This move had been widely telegraphed in recent weeks and was discounted as a near certainty in the Fed Funds futures market.
On a forward-looking basis, Fed Funds Futures markets now anticipate a December 2022 rate of 275-300 bp, which represents an additional 200 bp.
Additionally, the Fed announced it will commence quantitative tightening in the open market to reduce its balance sheet. The FOMC signaled that asset sales will begin at a pace of $47.5 billion per month and ramp up to $95 billion after three months. This is in line with what was signaled in the March FOMC meeting minutes. It is, notably, twice the pace of balance sheet reduction undertaken during the prior period of quantitative tightening (2017-2019).
Adding to the backdrop: The March 2022 CPI-U print increased 1.2% from February on a seasonally adjusted basis and the year-over-year inflation rate increased to 8.5% prior to seasonal adjustment.
We have long held that the hallmark of this cycle is uncertainty, and a faster pace of quantitative tightening posed the most significant exogenous threat to sustained elevated levels of excess liquidity. Now that this risk appears to be materializing, banks need to quickly unpack what it means for them.
At a system level, the base case is now that total deposit levels will fall modestly rather than rise. At a fully-implemented run rate of $1.1 trillion per year, the proposed quantitative tightening would amount to a 6% reduction on the base of $18.2 trillion in total bank deposits.
Curinos anticipates, however, this will be at least partially offset by the money multiplier effect as banks increase leverage through incremental credit extension. With total bank loans and leases at just over $11 trillion, banks loans would have to grow at a rate above 10% to fully offset the impact of quantitative tightening on system-wide deposit balances. But rising rates and additional macro uncertainty around geopolitics and public health means this level of growth seems improbable as a base case. As such, we would expect low single-digit declines in total deposit balances over the next 12 months.
Outcomes are likely to vary much more significantly at the individual bank level based on the magnitude and composition of the surge deposits acquired over the past two years.
In conclusion, the facts on the ground have changed materially relative to the beginning of the year. Banks should review their current funding forecasts in light of these developments and consider potential adjustments to their rising-rate playbooks.
Commercial deposit betas were modest following the 25 bp hike in March, with average MMDA rates rising two bp and IB DDA rates rising one bp through the end of March. (See Figure 1.) Weekly data from Curinos’ Comparative Deposit Analytics (CDA) indicate that average rates continued to trend modestly higher through April. Pockets of rate competition are beginning to emerge, however, with some institutions passing through significant rate increases. Additionally, while average commercial deposit balances remain up on a year-over-year basis, first-quarter growth has been soft even when considering normal seasonal factors in commercial books. And some institutions have experienced material outflows. (See Figure 2.)
We anticipate that these trends will be amplified by the actions the FOMC announced today. The faster pace of quantitative tightening will accelerate balance competition systemwide. And those institutions experiencing outflows will likely pull the rate lever sooner. This will likely spill over to push betas higher — even at institutions that don’t currently need the funding.
Figure 1: Change in Average Commercial Interest-Bearing Rates
Source: Curinos CDA
Figure 2: Deposit Growth, March 2022
Source: Curinos CDA
As expected, branch rates have largely lagged the first Fed increase, aligning to historical trends. Direct banks, however, have already increased rates more aggressively earlier in the cycle as compared with the last two rising-rate cycles. Direct-bank savings rates have increased by more than 10 bp and CD rates have increased even more substantially. Top-of-market 12-month CD rates are now above 1.25%, with five-year CDs above 2.00%. (See Figure 3.)
While excess liquidity and revenue pressures will continue to lead most branch banks to hold retail betas low, competitive pressure is likely to continue to increase following today’s rate increase, with a second 50 bp increase widely expected for the June meeting as well. Despite a much shorter elapsed time period, the magnitude of Fed increases would pass the point where the lag began to let up in the last two rising-rate environments.
Most banks will be able to keep betas well lower than the last cycle, but close attention to household and balance retention will be critical to ensure ground is not lost.
Figure 3: Direct Bank CD Rates Oct-21 — April-22, Top 10 Average
Sources: Curinos standard rate data
Lenders that built their balance of mortgage servicing rights (MSR) over the previous 24 months are seeing the benefits to their P&L as the value of the increase in base mortgage rates drives up the value of the MSRs. Lenders that chose to retain the rights to collect a monthly fee for servicing mortgages have seen the value of these rights increase as the likelihood of these loans paying off for a better rate diminishes. As prepayments fall, this is a natural hedge against a drop in loan origination revenue associated with a significant decrease in refinance volume from record highs the past two years.
Automated Savings Tools Grow Up
High inflation and rising rates may make it more difficult for some consumers to meet their savings goals, but a number of providers are developing tools and functions that can be easily customized and even used to reduce debt.
Leading banks have developed automated savings tools as part of their digital offerings as a way to motivate users to think about their savings performance more regularly and engage with their banking platform more often. That may seem like a contrary notion, but some providers have been able to combine effective automatic money movement functionality while still encouraging a higher level of participation.
Auto-deposit capabilities and the likes of round-ups and balance-related sweeping rules are becoming more common on leading banking apps, adding to the manual capabilities that have long been available. The ability to set up savings deposits at pre-established intervals and as the consumer spends has the obvious benefit of helping customers improve their financial health. But as rates rise and the external environment changes, automated saving functions need to contain configuration capabilities that encourage engagement.
Some providers are creating interactions that can be changed by the customer at any time. KeyBank’s EasyUp service triggers a transfer not only from checking to saving accounts, but also to a range of creditors every time the customer uses their debit card. The user can raise or lower the transfer amount every time they make a purchase. Revolut’s Vaults are constructed around the idea of customized savings goals and recurring transfers whose amounts can be changed. The deposit frequencies and amounts are entirely variable, so the
user can change the amount they want to save on a daily, weekly or monthly basis. Among its savings and goal tools, N26 provides users with the option of transferring a selected multiple of each rounded-up amount.
The ability of Revolut and N26 users to go beyond a single round-up to the nearest dollar or euro via a boost amount of twice, three times or five times per transaction could result in users achieving their savings goals more quickly or increasing their deposits to take advantage of improved returns.
Visualized target-performance assessment tools laid out in interactive dashboards work with these different savings functions to provoke regular engagement and significant buy-in through thoughtfully-constructed user experiences that minimize customer workload. By creating an engaging experience of monitoring and considering regular small or large steps on the journey towards a savings goal, providers can offset the discomfort felt by some of their customers as their cash position deteriorates.
Automation plays well into that. Banks are very aware that each customer has a unique savings mindset. Rigid savings tools, therefore, can limit a user’s ability to put money away or pay off debt. It should be noted that encouraging value-generating interactions should in no way be considered a dilution of automation. That element remains a pillar of these savings tools. If anything, flexible automation builds trust among users because they realize they are getting value from their digitally competent and forward-moving financial service provider.