KC Fed on Bank Deposits vs. MMFs
The Federal Reserve Bank of Kansas City published, "Bank Deposit Rates Haven't Kept Pace with Yields on Other Investments, but Depositors Are Staying Anyway," which says, "Bank deposit outflows continued during 2023 despite rising deposit rates. One possible explanation is that deposit rate increases have not kept pace with rising yields on other investments. For example, spreads between bank deposit rates and yields on deposit substitutes such as money market funds have reached historically high levels. Although the outlook for deposit rates depends on the policy rate path, deposit levels are likely to remain stable under alternative policy scenarios." It explains, "Over the past year, banks continued to experience deposit outflows. First, monetary policy actions increased short-term interest rates, which enticed many depositors to seek more profitable investment opportunities. Second, banking stress episodes led some large depositors to question the safety of bank deposits and seek alternatives. In response, banks raised deposit rates to retain their core funding. However, deposit rates have risen more slowly than yields on alternative investments.... [M]any depositors may be reluctant to move their money out of deposits even when interest rates offered on alternative investments are higher than bank deposit rates. However, some alternative investments, such as money market funds, may be close substitutes for deposits. Although money market funds do not offer the same payment services or loss guarantees as bank deposits, they do offer returns comparable to other short-term investments on funds that can be withdrawn at par value with limited risk. In addition, government money market funds pose virtually no credit risk because they are fully invested in assets issued or backed by the U.S. government. Many money market funds can also invest in the Federal Reserve’s Overnight Reverse Repurchase (ON RRP) facility, which provides participants short-term investments at an administered rate without imposing credit, interest rate, or counterparty risk." The KC Fed states, "Historically, yields on money market fund investments have moved nearly concurrently with short-term policy rates, while deposit rates have lagged.... Bank deposit accounts offer customers greater convenience than money market funds and are accordingly expected to have lower rates; however, the current spread is about double the peaks in past tightening cycles. Partly as a result, money market fund assets have grown, while deposits have declined. Chart 2 shows that from 2022:Q1 through 2023:Q3, money market funds (green line) experienced cumulative inflows of about $900 billion. Those inflows are almost exactly matched by the total amount of bank deposit outflows (blue line) during that time. Notably, both money market inflows and deposit outflows accelerated in March 2023, when high-profile bank failures led uninsured depositors to question the safety of their deposits. Government money market funds, in particular, benefitted from uninsured depositor flight (not shown)." Finally, the piece comments, "If policy rates remain elevated, the current spread between money market fund yields and deposit rates is still likely to narrow as bank deposit rates 'catch up.' ... Although the factors driving deposit rates and money market fund yields in these policy scenarios differ, bank deposit levels are likely to remain stable in both cases. Indeed, deposit outflows largely stabilized in the second half of 2023 as deposit rate increases have continued. Moreover, deposits remaining at banks are more likely to be held by depositors who value the convenience and safety of bank deposits over higher yields offered by alternative investments."
