☀️☕️ Money Markets vs Deposits vs The Economy?

📊 Also: Dovish Ueda (BOJ, JPY) 🎓️ Fractional Reserves and the Money MULTIPLIER

Apr 06, 2023

Happy Tuesday!

📝 Focus

Money Markets vs Deposits vs The Economy?

📊 In the Markets

Dovish Ueda (BOJ, JPY)

📖 MoneyFitt Explains

🎓️ Fractional Reserves and the Money MULTIPLIER

📝 Focus

Money Markets vs Deposits vs The Economy?

Last month's failures of Silicon Valley Bank and Signature Bank in the US led, understandably, to massive deposit outflows from small and midsize regional banks into larger, safer banks and money market funds (MMFs), Moody’s Analytics reported. With an easing of the crisis (for now) the drain on US bank deposits has slowed, with deposits falling by a seasonally adjusted $65bn in the last week of March from a decline of $172bn the previous week. But overall, more than $350bn flowed into MMFs in March.

- Image credit: Tenor

..... ► The surge into MMFs last month was largely for safety, but also for the better returns depositors get from those funds after a year of Fed interest rate hikes. After rates rose above 3% last November, the pace of MMF inflows began to pick up. Because they invest in short-maturity Treasury securities whose yield closely tracks the Fed funds rate, they're now offering 4.5%. MMFs sucked in $250bn in the second half of March alone, increasing the pressure on all banks --smaller ones especially-- to offer more competitive deposit rates and eating into their net interest margins (the difference between what they pay depositors and what they get from loans they make.)

..... ► Moody's adds that in recent years, MMFs have also had access to the Fed’s "reverse repo facility" allowing funds to park cash with the Fed overnight and get an interest rate just under the Federal Funds rate. Outstanding transactions in the facility grew from almost nothing in early 2021 to around US$2 trillion, driven mainly by MMF holdings. Decent interest rate and ultra-safe, hence very competitive with deposits from banks of all sizes.

..... ► As Matt Levine of Bloomberg noted (in his piece on The Narrow Bank), MMFs have "few of the expenses of traditional banking (no loan officers, no branches, no capital requirements), so it can pass along a lot of the interest to investors" and take "no credit risk or interest-rate risk, and it can tell investors 'your money is much safer here than at a regular bank, since we just park 100% of it at the Fed.'” So it turns out that the Fed is effectively (and inadvertently?) competing with the banking system for deposits.

..... ► But by competing with these deposits through the MMFs, money is sucked into the Fed with a MULTIPLIER EFFECT on the amount of money circulating in the economy via the Fractional Reserve Banking system 🎓. This is sort of what the Fed wants in order to fight inflation... provided it doesn't overshoot (for example, when a banking crisis causes panic and a gigantic flight to MMFs) leading to a massive credit crunch (a sudden sharp fall in the amount of money available to borrowers from banks) that tips the economy into a deep recession.

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📊 In the Markets

Markets closed little changed on Monday but started the session weak on a knee-jerk drop on worries after the Friday nonfarm payroll data (showing that the US labour market remained firm in March) that interest rates would likely rise again in May.

..... ► Tech names were weak, led by Apple on news of Mac sales falling 40% in the first three months of the year, even faster than regular PC sales (-30%) with a drop in market share from 8.6% to 7.2%, according to IDC data. The overall weakness reflects both a return to pre-pandemic patterns and also channel inventories that remain high despite heavy discounting. Micron, on the other hand, rallied 8% on news of memory chip market leader Samsung’s belated plans to cut production, which should hasten the end of the cyclical glut.

On Friday, the first quarter earnings season kicks off with three big banks, Citigroup, JPMorgan and Wells Fargo. Investors will be looking for clues on the sector's overall health and implications for the economy after March’s bank crisis that saw two US regional banks fail and Credit Suisse fall into the unloving arms of its arch-rival UBS. (See Focus story above.)

..... ► The Fed’s new emergency lending programme, the Bank Term Funding Program, created when Silicon Valley Bank and Signature Bank fell, saw stable borrowings last week, averaging $68bn, up from $63bn. Along with the discount window down to $71bn from $105bn the previous week, direct banking sector stress seems somewhat under control (for now.)

Soft sales plus inflation and interest cost-squeezed margins are expected to hit total S&P500 company earnings, leading to a drop of 5-7% compared to the first quarter of 2022. This would be the biggest drop since the 30% collapse in the Covid-whacked second quarter of 2020. Actual results can, of course, come in higher or lower than the estimates of Wall Street's Finest, but with expectations this subdued, there is the chance of an upside surprise.

..... ► The S&P500 is up over 6% this year, but 90% of that improvement was driven by just 20 large stocks, led by Nvidia +83%, FB & IG owner Meta +76% and Salesforce +42%, which more than made up for a pretty weak performance from the rest of the stock market.

Dovish Ueda (BOJ, JPY)

Meanwhile, in Japan, the US Dollar rose as the Japanese Yen weakened after new central bank governor Kazuo Ueda showed a more dovish side than some in the market had been hoping for, saying he would maintain the bank's ultra-loose monetary policy... for now. (See yesterday's MFM Focus.)

"When looking at current economic, price and financial developments, it's appropriate to maintain yield curve control for now,"

Kazuo Ueda, Governor of the Bank of Japan

..... ► The reasoning is that inflation has yet to hit 2% as a long-term trend and more time is needed to determine whether or not wages will keep rising. Even under the former BoJ governor, the key prerequisite for an exit from ultra-loose policy settings was where inflation is backed by wage growth. This suggests no rush to ease back on --far less reverse-- its massive Abenomics-era economic stimulus, including negative interest rates and the controversial Yield Curve Control. (See below.)

..... ► On the other hand, in his inaugural press conference as the new governor, Ueda also said that the Bank of Japan must also avoid being too late in normalising monetary policy. This is a sign he may be dovish, but less so than his predecessor. If the Yen weakens further, squeezing domestic consumption (again) he may be more open to the idea of tweaking its controversial bond yield control policy (as the BOJ did last year when it broke JPY150 to the dollar.)

🎓 Japan's Yield Curve Control (YCC) - a mini-explainer

YCC is a policy by the Bank of Japan (BoJ) in which the central bank targets government bonds of different maturities to keep the yield on those bonds within a specified target range (in effect buying up enormous amounts).
It was introduced in 2016 as an unconventional monetary policy to influence long-term interest rates in order to stimulate economic growth and achieve price stability, as "Quantitative Easing" by buying Japanese Government Bonds was insufficient.
Critics argue the YCC has not been effective in achieving these goals and that the BoJ's interest rate manipulation has distorted financial markets

📖 MoneyFitt Explains

🎓️ The Fractional Reserve Banking system

Banks are required to hold a share of their deposits in reserve, either in their vaults or with the central bank. It is the core element of the fractional reserve banking system.
When the bank lends out the balance of its deposits, it can earn interest and make a profit. In doing so, it also creates a new asset (the loan) and a new liability (the deposit made by the borrower, in whichever bank it ends up in.)
The banks that receive the deposits can then lend out that amount less the RRR, and so on and so on. This increases the money supply by the “money MULTIPLIER”, which is 1/RRR (where RRR is the reserve ratio requirement.)
(The smaller the RRR, the bigger the multiplier and is one of many tools that central banks can use to manage the money supply and maintain stability in the economy. Lowering the reserve ratio increases the amount of money banks can lend, leading to an increase in the money supply, which stimulates economic activity, and vice versa.)