Evening Brief – 04.07.23

The panic in the banking system may be abating (or maybe we just hit the pause button) as the Federal Reserve’s balance sheet shrunk this week, falling by $101bn in two weeks to $8.63 trillion, as QT continued at the normal pace and as banks have started paying back the liquidity support offered by the Fed when SVB and Signature Bank collapsed, and a week later when, under pressure from Suisse regulators, Credit Suisse was taken over by UBS.

During the last post-meeting press conference, Powell explained this new regime – the distinction between ongoing tightening and brief liquidity support for the banks, and that both can run simultaneously.

Despite less trips to the discount window from financial institutions, the concerning news is that there continues to be a flight of deposits out of banks and into money market mutual funds that SVB’s failure simply accelerated.

Money market funds have a respectable yield, while many checking accounts do not. A record $304bn has poured into these funds over the last three weeks, driving the total assets invested to more than $5tn. The funds saw their third largest ever monthly inflow in March.

Much of that money is going into overnight reverse repurchase facilities (RRP), where funds can get as much as a 4.8% return, in exchange for securities such as Treasuries and then return the money the next day. The concern is that if investors can get such enticing yields, they might continue to avoid banks. In turn, the banks have less cash to push through the economy in the form of loans.

The surge in cash moving into the safest of money-market mutual funds has only just begun with as much as another $1.5tn expected to enter over the next year, according to Barclays Plc.

The flight into these funds may last at least until there are rapid rate cuts that will aggressively bring down those yields.