LAKE FOREST, Ill.—As the Major League Baseball season gets under way, the Federal Reserve has struck out twice with its last two rate moves, according to one economist who suggests if financial institutions raise their deposit rates the central bank will likely hold off on any further rate increases over next two years.
Michael Moebs, economist and CEO at Moebs $ervices, contends the last two rate hikes were a mistake for the health of the economy, and believes at this point Fed rate reductions would be helpful. But Moebs also is predicting rates will hold fairly steady over the coming 12-24 months, and may even inch up.
“If President Trump keeps putting pressure on Fed Chair (Jay) Powell there could be one or two decreases in 2019. It is obvious from the Moebs Interest Rate Study the Fed increased rates two times too much in 2018,” said Moebs. “Yet, if the Fed decreases rates it would be signaling it made a mistake. I do not think the Fed will admit it made a mistake.”
The most likely scenario, said Moebs, is interest rates will remain neutral or flat.
“This position of no changes to interest rates will hold true, especially if the economy continues with 2%-3% growth rate with stable inflation, low unemployment and moderate wage growth.”
Why the Swing & Miss?
Moebs contends if the Fed’s decisions are data dependent, how could it swing and miss on its last two hikes, totally whiffing on deposit pricing?
“Jane and Joe depositors at banks, credit unions, thrifts and fintech firms are getting far less than the fed funds rate for their savings,” said Moebs. “Betty and Bill small business people are getting less, too. If the Fed wants to increase rates back to pre-Great Recession levels—2008 and before, it must factor deposit pricing into its decisioning,” Moebs insisted.
The major conclusion of the Moebs $ervices Interest Rate Study is the gap between deposit pricing and the Federal Funds rate is enormous and peaking close to that of the Depression Era, said Moebs.
“This gap has to be narrowed by increases in deposit pricing by financial institutions,” Moebs said. “The sequence is: Fed Funds rate, deposit pricing, Treasury bills, Treasury bonds. Leave out any one rate in the sequence and the Fed will strike out every time.”
For all depositories including fintech firms, combined interest expense divided by $19.2 trillion (combined assets of all banks, thrifts, credit unions and fintechs) in assets is 0.62%, pointed put Moebs.
An Example to Watch
“This is more than double the 0.30% interest expense/assets in 2015, which is the low point for this millennium,” Moebs explained. “The largest deposit service is money market deposit accounts (MMDAs) at 47.9% of $19.7 trillion of combined depository assets. MMDAs are paying 0.20%, or only 8% of the fed funds rate. This shows how off the Fed is at getting a hit.”
Moebs said a good example of the gap between deposit pricing and Fed pricing are the one-year CD and one-year Treasury bill rates.
“The 12-month CD rate is used since it closely reflects the total interest expense/assets of depositories and fintech firms,” explained Moebs. “As of the Fed’s meeting on March 20, the 12-month CD was paying 0.71% and the 12-month T-bill was paying 2.47%. Why such a difference between deposit and Fed rates?”
As bond and T-bill rates have been falling in the weeks leading up to the last Fed meeting, Moebs pointed out an inversion in rates has occurred. CUToday.info recently reported that long-term yields fell below yields on short-term bonds—the so-called “yield curve inversion”—an occurrence that has preceded every recession over the last 60 years.
“The Fed Funds rate is more than the 12-month Treasury rate. Or, short rates are higher than long rates. The bond market is saying to the Fed the Fed Funds rate is too high,” Moebs said.
Moebs explained that under normal conditions most depository rates are about half of the Treasury or Fed Funds rate.
“Savers are riskless folks who shun investing in bonds or stocks,” he said. “In addition, they want deposit insurance to prove they won’t lose a penny of their hard-earned money. This has been a standard, normal gap for decades. Yet, there is an excess gap between the normal 12-month CD rate and the actual rate being paid by depositories and fintech firms. This difference is 0.53% (norm is 1.24% and actual 0.71%). These two excess gaps reflect the Fed’s last two attempts to make a hit. The market is not agreeing with the Fed’s last two rate moves.”
So what should the Fed do?
“Fed Chair Powell signaled in the Fed’s March 20 meeting no more increases in the Fed Fund rate in 2019, and maybe one change in 2020,” noted Moebs, acknowledging more rate increases could be coming. “Chair Powell is really saying he wants banks, credit unions, thrifts and fintech firms to increase their deposit rates at least 50 basis points over the next two years. If they do raise rates, he will not increase rates.”
Unless the inversion in the bond markets gets worse, deposit rates will increase and Fed Funds and Treasury rates will not, said Moebs.
“Yet this position could get rained out from any one of the following factors: the Fed’s balance sheet, excess reserves by all financial institutions, Brexit, and trade negotiations,” said Moebs.
Moebs said credit unions, banks, thrifts and fintech firms need to plan on a 0.25% rise in deposit expense in 2019.
“A quarter point in 2019 and potentially in 2020 fits nicely with the Fed’s neutral monetary policy position it has stated,” said Moebs. “I am also predicting the White Sox to beat the Cubs in the World Series.”