As expected, the FOMC held the Fed Funds rate unchanged at a target range of 5.25% to 5.5%. The Summary of Economic Projections (SEP) reflected the market consensus coming into the meeting that the Fed Funds rate has reached a peak level for this cycle. The forward–looking outlook in the dot plots was modestly more dovish than the September SEP and now indicates a most likely outlook of 75 bp of rate cuts in 2024. While this change has resulted in meaningful swings in fixed income markets, it does not dramatically change the outlook for bank deposits in 2024.
Given this emerging consensus, now’s a good time to take stock of how this cycle has played out to date and what the implications may be going forward.
A Look Back
The Fed Funds rate is at its highest level since 2001 (though 2007 was close) and the last time the Fed raised rates this quickly was in 1981. This rapid increase came after nearly 14 years of a zero- or near-zero-rate environment. During that span, dramatic changes in bank regulation removed barriers to customer access to interest-bearing bank deposits (Reg. Q, Reg. D), and technological advances revolutionized the way people and companies gained access to and moved their money – the last time rates were at current levels was around the time of the initial iPhone release. Finally, this cycle has taken place during an unprecedented expansion of the Fed’s balance sheet, followed by a $95 billion-per-month unwind.
All of this is to say that there’s value in looking at what has been both the same and different in this cycle, but there are also limits to what inferences we can draw from the past.
Where We Are Now
Some things that were old are new again. Consumers have piled back into CDs, which now make up 20% (up from 7%) of the total consumer market and 8% (up from 2%) of the total wealth market. And contrary to what some might believe, they’re not held just by individuals who are old enough to have had a bank account the last time rates were this high. In fact, Curinos has found that affluence, not age, is the key driver of CD demand – though there’s a strong correlation between the two. In the commercial space, companies have placed a renewed emphasis on managing their cash-conversion cycle, a key discipline in a higher-rate environment.
Some things have looked different from the previous tightening cycle. Betas started out slowly as banks entered the cycle flush with liquidity and anticipated a more gradual pace of rate increases. But in the more rate-sensitive segments, competition quickly intensified and betas have now far outpaced the last cycle, when betas for commercial MMDA topped out at about 50% and were just shy of 40% for commercial interest checking. By comparison, betas in this cycle are now over 70% for commercial MMDA and over 50% for commercial interest checking. The gap between branch and digital banks has also increased. Branch banks have seen a large pandemic-driven build-up in checking deposits decreasing because of both inflation and rate-driven rotation, with the latter moving both internally, to CDs, and externally, to digital banks.
The bank receiverships of early 2023 punctuated the cycle. Some of the impacts proved much more transient than expected at the time, while others have been durable. Flows of commercial deposits into insured cash sweep products leveled off quickly for most banks, and the vast majority of commercial deposits remain uninsured. Similarly, despite many companies talking about strategies to mitigate operational and financial exposure to their banks, churn increased only modestly and the “flight to big” was short lived. In fact, by the third quarter, most regional banks outperformed the nationals and super-regionals on commercial deposit growth. But some behavioral changes persist, especially in the wealth market, where cash-sorting from deposits to money market mutual funds has created ongoing challenges to balance growth.
What’s Likely To Come
Despite some emerging trends, the Fed plateau presents some significant unknowns. The first is what will happen to the remaining back books. Retail banks continue to sit on 36% of savings deposits earning less than 10 bp, and whether the Fed Funds rate is in the mid-5% or the mid-4% range, that’s an enormous difference.
Another is the degree to which commercial customers remain content to leave deposit balances in non-interest-bearing accounts and use earnings credits to offset bank fees. Nearly one-third of commercial balances remain in non-interest-bearing accounts, but that’s down from nearly 50% at the start of the cycle. Whether or not these remaining balances “wake up” through a Fed plateau will have a significant impact on total portfolio costs. And what will happen in the market itself is, of course, unknown. While the forward curve and dot plots are coalescing around a gradual reduction in the Fed Funds rate in 2024, the current cycle has taught us to be wary of crystal balls. On the eve of this current cycle, markets were expecting closer to 50 bp of hikes than the 500 bp that transpired.
The bottom line is that while the Fed may be done with this round of hikes, the impacts of the cycle are still rippling through deposit markets. And even if the path of rates plays out in line with the forward curve, these impacts are likely continue into 2024.