Will deposit rates rise faster?
Historically, banks tend to lag when repricing deposit rates after the Fed has increased the policy rate. This tends to be more true for retail consumer deposits than for corporate deposits since institutions (i.e. corporate treasurers) are watching the markets and will move their funds to optimize yield if the bank doesn’t increase their rate.
To illustrate this, I’ve plotted monthly observations of historical rates since 2002 from Bankrate.com national average rate for 1 year CD, Money Market Deposit Account versus the Fed Funds Rate. I also show the yield on Vanguard’s Federal Money Market Fund, which tracks very closely the rate of Fed Funds. The reason is that many people assume that the yield they earn in their Money Market Account at a bank is the same as the rate in a Money Market Fund when they are very different. Bank’s created the Money Market Account to compete with Money Market Funds but they don’t actually invest the deposits into Money Market Instruments and they do not pass the earnings from these investments to depositors. Banks have the freedom to charge whatever they like for funds in the Money Market Account. It is really just a bank savings account where they added the term “Money Market” to give the idea that the yield will be comparable.
In reality the “Beta” or how much of the rate change from the benchmark rate (Fed Funds Rate) that is passed to Money Market Funds is around 100% (as you can see in the plot above as they move together in sync), but for bank deposits termed Money Market Accounts, it has been 20%-80% for retail clients and perhaps 40%-100% for business and corporate clients. Note the “Beta” for the Bankrate.com national average is more representative of retail customer since corporate deposit rates are more bespoke and not published. I would also add that the Bankrate.com is more heavily weighted by the larger banks and one can see more competitive rates from online banks and neo banks.
To more clearly show the money market account deposit betas (how much the deposit rate changed as a ratio of how much the underlying indexed rate changed), I plotted below the cumulative change in the deposit rate versus the cumulative change of the benchmark rate for the prior 2 rising rate cycles. The rising rate cycle from March 2004 to August 2007 was much more aggressive and banks increased their rates much faster. The more recent rising rate cycle from November 2015 to July 2019 was more gradual as the Fed was being careful to not hurt economic growth.
Based on the above, one can see that on average banks took about 6 months before passing any increase in the Fed Funds rate to the money market account during the 2004–2007 cycle while it took over 1 year for banks to increase deposit rates during the 2015–2019 cycle.
In my prior post about what the market has priced in for Fed Funds rate expectations, it is expected the Fed Funds rate may reach 3% by Q1 of 2023 (in 1 year from this post), which is about 250bps rate increase. If we take a look at history, we can then assume that on average 50% of that or 125bps would be passed on the bank money market deposit accounts (if banks followed the 2004–2007 rate cycle) but only around 50bps increase or 20% would be passed if banks follow the strategy during the prior rate cycle. Thus, you can expect that if you are earning 10bps in your money market account today, you would earn 60bps in one year but this increase would be gradual and lagged.
The reason why banks repriced less aggressively in the 2015–2019 rate cycle versus 2004–2007 rate cycle is because banks had to deal with higher regulatory requirements, which increased costs. As a result, banks were able to more effectively use of their customer data and split them into cohorts that are expected to be rate sensitive and those that are not. As the rate increase in 2015–2019 was gradual and still relatively low when the Fed Funds rate was at 2%, the opportunity cost of switching banks was not enough of an incentive for most retail customers to react. Neo banks and FinTechs were able to capture some marketshare by offering higher yielding online savings accounts but consumers were not yet willing to go fully digital.
As the Pandemic as sped up the digital adoption of online banks as well as cryptocurrency and DeFi options such as earning yield on stablecoins, I would expect to see more competition in this rising rate cycle than what we saw in 2015–2018. Additionally, consumers are feeling the inflation at 8.5% and are more actively looking for alternatives. I don’t think banks can assume that retail customers are willing to wait 1 year before yields increase in their money market accounts before they react as they had done back in 2015–2018. However, banks are sitting on excess liquidity (glut of deposits) that was acquired since the Pandemic started in March of 2020 and may not necessarily be aggressive when repricing their deposits until balances start to leave. I believe the consumers are “woke” now and if money market accounts do not reprice at least 50% of the change in Fed Funds after 3–6 months, they will move it.
