A counterintuitive development in recent months, in the context of recession concerns in America, has been the pickup in American commercial bank lending and in particular rising commercial and industrial (C&I) loans.
Commercial banks’ total loans and C&I loans rose by 11.6% YoY and 13.6% YoY, respectively, in the week ended 15 February, though, it should be noted, down from a recent high of 12.5% YoY and 16.3% YoY reached in early December/late November.
US commercial banks’ total loan growth and commercial & industrial (C&I) loans
Note: Data up to the week ended 15 February 2023. Source: Federal Reserve
US high-yield corporate bond issuance, for example, has fallen by 90% from a peak of US$156bn in 1Q21 to US$15.9bn in 4Q22, though it rose to US$21.8bn in January.
US high-yield corporate bond issuance
Source: SIFMA
Meanwhile, US nominal GDP rose by 7.4% YoY in 4Q22, compared with a pre-pandemic growth rate of 4.3% YoY in 4Q19, though down from 17.4% YoY in 2Q21 which was boosted by the base effect.
It is also the case that, with interest rates rising, it has become more interesting for banks to lend even as they are in no hurry to raise deposit rates in line with Fed tightening.
US nominal GDP growth
Source: Bureau of Economic Analysis
Interestingly, this increase in bank lending is also taking place at the same time as banks’ holdings of Treasury bonds continue to decline as do their reserves, formerly known as excess reserves.
Thus, US large domestically chartered commercial banks’ holdings of US Treasuries and non-MBS agency debt have declined by US$141bn or 10.4% from a peak of US$1.359tn in February 2022 to US$1.217tn as of 15 February, while their C&I loans have risen by US$179bn or 13.6% from US$1.318tn to US$1.497tn over the same period.
US large commercial banks’ balance sheet: Holdings of Treasuries vs C&I loans
Source: Federal Reserve
The large domestic banks are defined by the Fed as the top 25 domestically chartered commercial banks by domestic assets.
As for total bank reserves, they have declined by US$1.259tn or 29% from a peak of US$4.276tn in December 2021 to US$3.016tn in the week ended 22 February.
US bank reserves
Source: Federal Reserve
Consumer Deposits are Leaving the Banks
It is also worth remembering that the Fed is now paying commercial banks 4.65% on these reserves.
By contrast, the average depositor was earning only 0.35% on his/her bank savings deposits, and 1.36% on one-year deposits as of 21 February, according to the Federal Deposit Insurance Corporation (FDIC).
This raises the issue of the potential for savings to move from bank deposits to money market funds (MMFs), which offer on average a significantly higher deposit rate and now have a certain element of government guarantee following what happened in 2008 when a crisis in the commercial paper market caused a retail money market fund “to break the buck” for the first time ever.
The regulatory changes which came into effect in October 2016 require prime MMFs to adopt a system of redemption gates and liquidity fees, while institutional MMFs have to value their shares at market price.
By contrast, government MMFs have not been affected by the regulations.
As a consequence, many prime MMFs have been converted to government MMFs, which invest in low-risk assets such as cash, government securities, and repos.
Indeed, the government MMF category now accounts for a dominant 76% of total money market fund assets, up from only 34% in 2014, according to the Securities and Exchange Commission.
The government MMFs now yield 4.1% or, a seemingly compelling 274bp above prevailing average one-year bank deposit rates.
It is further worth noting that the Fed launched its reverse repo (RRP) programme in 2013, which, crucially, MMFs have access to.
The MMFs have now invested US$1.99tn or 38% of their total assets in reverse repo agreements with the Fed, while the Fed now pays 4.55% on the overnight RRPs.
US money market fund assets
Note: Monthly data up to January 2023. Source: US Securities and Exchange Commission (SEC)
Banks Losing Deposits = Less of a Credit Multiplier
Clearly, the significance of a potential flow of savings from commercial bank deposits to money market funds is that it would reduce the ability of the system to leverage up via the expansion of the credit multiplier.
So depositor inertia, or the lack of it, has now become a key issue in America as regards liquidity trends.
Certainly, money markets funds now offer a competitive rate of return.
For example, the Fidelity Government MMF has risen by 1.9% on a total-return basis since the beginning of 2022, while the S&P500 and the Bloomberg US Long Treasury (10Y+) bond index are down 15.1% and 28.8% respectively over the same period.
Fidelity Government MMF, S&P500 and long-term Treasury bonds total-return performance
Source: Bloomberg
The start of a trend of deposit outflows into money market funds is evident from the weekly data on MMF assets from the Investment Company Institute and the Fed’s weekly data on bank deposits.
Thus, US bank deposits peaked at US$18.13tn in April 2022 and have since declined by US$476bn or 2.6% to US$17.66bn in mid-February, while US MMFs’ total assets have risen by US$351bn or 7.9% from US$4.47tn in April 2022 to US$4.82tn in the week ended 22 February.
US bank deposits and MMF assets (weekly)
Note: Data up to the week ended 15 February for bank deposits and 22 February for MMF assets.
Source: Bloomberg, Federal Reserve, Investment Company Institute.
About Author
The views expressed in Chris Wood’s column on Grizzle reflect Chris Wood’s personal opinion only, and they have not been reviewed or endorsed by Jefferies. The information in the column has not been reviewed or verified by Jefferies. None of Jefferies, its affiliates or employees, directors or officers shall have any liability whatsoever in connection with the content published on this website.
The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Grizzle hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.