Interesting....
Summary?
Conclusion?
Recommendation to community banks?
------------------------------
Mary Fowler
Chief Executive Officer
The Peoples Bank
Magnolia AR
------------------------------
-------------------------------------------
Original Message:
Sent: 07-06-2019 11:49
From: Neil Stanley
Subject: What is the Supply and Demand for Money Doing to Interest Rates?
In a capitalistic society the supply and demand for a resource ultimately determines its price. For money that price is interest rate. Because the Federal Reserve sets the overnight interest rates for banks to borrow money, they are a key influence in interest rates. But, not the only determinant. Investors buying bonds across the maturity terms signal their expectations as they determine market rates of interest. The speculative opportunities with bond gains provides incentives that don't exist in other less liquid fixed income alternatives. To be certain, bond speculators are a key determinant of the price of money as they set US Treasury and FHLB advance rate levels.
Fixed income investments can have a spectrum of risk. Bond holders in the great recession dramatically discovered this. The guiding principle for scared depositors was simple, safe, and predictable. If it earned interest, then that was a bonus.
Today, your bank can borrow money from depositors or from the wholesale markets. To your depositors who are within the FDIC insurance limits, there is no more credit risk in investing in a deposit in your bank than in the comparable term US Treasury. So, why are US Treasuries so much below the current offering rates of many banks and credit unions? See the attached graphic. This is a great topic that could be explored more thoroughly.
When it comes to the direction of interest rates, forecasts for falling rates are readily observed today. Does the fact that our environment is so different than the great recession mean we will not retreat interest rates back toward Great Recession levels? What is different? Here are a few items that are notably different despite any Federal Reserve and bond market activity...
- The recent increases in banking industry earnings tend to intensify competition for all bank offerings. Surging industry earnings are generally inconsistent with falling interest rates. High banking industry earnings were not the case when the Fed drove Fed Funds targets to .25% in 2008. Just check the data at FDIC.gov to see the dramatic industry earnings levels.
- Banks and credit unions are competing aggressively to grow franchise value thereby increasing the demand for deposits. Bank investors were in a mode of preserving capital in the Great Recession as they shrunk their balance sheets. Today, banks are seeking to grow their franchise value. This is not done through outsourcing of funding. It is done by creating relationships with depositors who have a spectrum of financial services needs. With bank valuations now at healthy multiples, bankers have a valid motivation to grow both sides of the balance sheet with non-wholesale activity.
- The demand for loans has been generally steady (the demand for deposits is a derived demand dependent on borrowing demand). We have steady loan demand which has to be funded. Bankers will actively choose between sometimes cheaper outsourced/wholesale funding and local/franchise building/regulatory endorsed deposits.
- Where is the fear in current and potential depositors driving them to your bank like the days of surge deposits that were part of the industry's ability to sustain record low levels of interest rates?
If you think general interest rates will go back toward where they were in the Great Recession how do you factor in all of these major differences between then and our current scenario today?
Generally, the Fed only changes direction to lower interest rates when there is evidence of a current financial crisis. Is there a crisis in unemployment; GDP; or inflation? Since the Fed began raising interest rates look at what has happened to long-term interest rates and the stock market. The 10-year treasury is currently very close to where it was in 2008 when the Fed lowered rates to .25%. This means that consumer and business capital investment cost remains attractive. Seems like an economically accommodative posture to me. Recent interest rates don't seem to have stifled the stock market.
Simplistic notions that an inverted yield curve leads to a recession dismisses the many factors beyond Fed policy on the short term and bond speculation impact on the longer term levels of interest rates. Some fundamental analysis of the actual supply and demand for money is necessary if we want to anticipate likely interest rate scenarios that will impact banking.
------------------------------
Neil Stanley
TS Banking Group
Treynor, Iowa
------------------------------
Summary?
Conclusion?
Recommendation to community banks?
------------------------------
Mary Fowler
Chief Executive Officer
The Peoples Bank
Magnolia AR
------------------------------
-------------------------------------------
Original Message:
Sent: 07-06-2019 11:49
From: Neil Stanley
Subject: What is the Supply and Demand for Money Doing to Interest Rates?
In a capitalistic society the supply and demand for a resource ultimately determines its price. For money that price is interest rate. Because the Federal Reserve sets the overnight interest rates for banks to borrow money, they are a key influence in interest rates. But, not the only determinant. Investors buying bonds across the maturity terms signal their expectations as they determine market rates of interest. The speculative opportunities with bond gains provides incentives that don't exist in other less liquid fixed income alternatives. To be certain, bond speculators are a key determinant of the price of money as they set US Treasury and FHLB advance rate levels.
Fixed income investments can have a spectrum of risk. Bond holders in the great recession dramatically discovered this. The guiding principle for scared depositors was simple, safe, and predictable. If it earned interest, then that was a bonus.
Today, your bank can borrow money from depositors or from the wholesale markets. To your depositors who are within the FDIC insurance limits, there is no more credit risk in investing in a deposit in your bank than in the comparable term US Treasury. So, why are US Treasuries so much below the current offering rates of many banks and credit unions? See the attached graphic. This is a great topic that could be explored more thoroughly.
When it comes to the direction of interest rates, forecasts for falling rates are readily observed today. Does the fact that our environment is so different than the great recession mean we will not retreat interest rates back toward Great Recession levels? What is different? Here are a few items that are notably different despite any Federal Reserve and bond market activity...
- The recent increases in banking industry earnings tend to intensify competition for all bank offerings. Surging industry earnings are generally inconsistent with falling interest rates. High banking industry earnings were not the case when the Fed drove Fed Funds targets to .25% in 2008. Just check the data at FDIC.gov to see the dramatic industry earnings levels.
- Banks and credit unions are competing aggressively to grow franchise value thereby increasing the demand for deposits. Bank investors were in a mode of preserving capital in the Great Recession as they shrunk their balance sheets. Today, banks are seeking to grow their franchise value. This is not done through outsourcing of funding. It is done by creating relationships with depositors who have a spectrum of financial services needs. With bank valuations now at healthy multiples, bankers have a valid motivation to grow both sides of the balance sheet with non-wholesale activity.
- The demand for loans has been generally steady (the demand for deposits is a derived demand dependent on borrowing demand). We have steady loan demand which has to be funded. Bankers will actively choose between sometimes cheaper outsourced/wholesale funding and local/franchise building/regulatory endorsed deposits.
- Where is the fear in current and potential depositors driving them to your bank like the days of surge deposits that were part of the industry's ability to sustain record low levels of interest rates?
If you think general interest rates will go back toward where they were in the Great Recession how do you factor in all of these major differences between then and our current scenario today?
Generally, the Fed only changes direction to lower interest rates when there is evidence of a current financial crisis. Is there a crisis in unemployment; GDP; or inflation? Since the Fed began raising interest rates look at what has happened to long-term interest rates and the stock market. The 10-year treasury is currently very close to where it was in 2008 when the Fed lowered rates to .25%. This means that consumer and business capital investment cost remains attractive. Seems like an economically accommodative posture to me. Recent interest rates don't seem to have stifled the stock market.
Simplistic notions that an inverted yield curve leads to a recession dismisses the many factors beyond Fed policy on the short term and bond speculation impact on the longer term levels of interest rates. Some fundamental analysis of the actual supply and demand for money is necessary if we want to anticipate likely interest rate scenarios that will impact banking.
------------------------------
Neil Stanley
TS Banking Group
Treynor, Iowa
------------------------------
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