The tide is turning on money fund dominance, with deposits returning to banks amid better pricing.
After two strong years of money market fund (MMF) flows, it appears the tide is turning as banks pay up and reported strong deposit growth in the first quarter. High rates, in conjunction with the regional banking turmoil last year, sent depositors from traditional banks to money market funds in order to generate some yield on their cash. Since the high-water mark in Q1 2022, there has been a cumulative 3.4% decline in deposits across the US banking system, which included four straight quarters of deposit declines. Over that same period, money market fund growth of 27% was fairly astounding with seven straight quarters of increases. This trend is exhibited in the directional flow analysis, which shows that money fund growth has outpaced deposit growth since the second quarter of 2022 and signals that depositors/investors have favored money funds during that period. However, the trend has begun to change, and the flow is now closer to equilibrium (even growth between MMF and deposits). US banks have reported that their net interest margins have peaked due to higher deposit pricing as the banks have finally begun to offer more competitive deposit rates, which has drawn depositors back over the last three quarters. While money funds are still seeing growth, that growth has slowed, and bank products like CDs and high-yield savings accounts (HYSA) have become much more competitive from a rate perspective. Additionally, economic and rate uncertainty tends to cause depositors to move to insured bank deposits. So, with the US election coming later this year and expectations for Fed rate cuts continuing to be pushed back, a continuation in deposit growth and slower flows to MMFs seems most likely.
Return of equity to debt risk transfer may be innocuous, for now.
Constituents of the S&P 500 are spending! Financing gap data supports management teams’ claims of reinvestment, but returns to shareholders have also remained near record levels. During the most recent quarterly reporting period, management frequently cited continued appetite for repurchases, which supports the strong equity markets. However, stronger equities are being supported by debt. In spite of the very high interest rates, new issuance of fixed-income securities was heavy during the first and second quarters, supplying companies with funds for discretionary uses. From the credit investors’ perspective, reinvestment is a positive, as the use of debt to fund share purchases is a transfer of risk from debt to equity. Although current net debt loads are not particularly concerning, the interest burden could become a more meaningful risk if rates remain elevated and debt cannot be refinanced at more favorable terms. On balance, though, Public Trust benefits from the higher levels paid as providers of short-term funding, and the longer-term questions will become clearer over time.
Credit card balances grow, and auto lending slows down for average consumers.
Credit card balances totaled $1.12 trillion in 1Q24, just shy of the 4Q23 $1.13 trillion all-time high. As credit card balances increased, credit card delinquencies have followed suit. As we expected during the prior Credit Market Update, delinquencies continued to climb and exceeded 10% in 1Q24 for the first time since 2013. Net charge-offs, which lag delinquencies, increased to 2.3% in April 2024, with some major banks expecting charge-offs to increase to 3.5% by late summer as a growing number of consumers cannot keep up with their payments. The more pressured economic environment has also impacted auto lending as volume increased 7% YoY for the highest credit quality borrowers (FICO 760+) while declining by 3.9% for more average borrowers (FICO 620-759). Most interestingly, lending volume increased 12% YoY for the least creditworthy borrowers (FICO <620) despite many lenders asserting that lending standards had tightened. This trend is likely due to the volume of loans for the highest quality borrowers being nearly 2.5x that of the lowest quality borrowers. This enables lenders to enhance their returns by taking some hedged risk in issuing more profitable loans to lower-quality borrowers
Home prices continue to breach record highs despite elevated interest rates.
The US housing market continues to show its strength, as house prices tracked by the Case-Shiller US National Home Price Index again reached record highs in Q1. While many predicted that rising rates would cool the housing market, which happened briefly in 2022, the housing market is again setting record highs as demand continues to outpace supply. Another key factor pushing housing prices higher is that “commercial interests,” mainly private equity funds, are scooping up large amounts of investable residential real estate across the country. One report from Fort Worth, Texas, for example, found that these commercial interests owned approximately 26% of single-family homes in the area. Commercial investors continuing their push into residential real estate has an upward effect on prices by lowering the supply of properties on the market, and with private funds largely flush with cash, we expect this trend will continue. Additionally, once interest rates begin to decline and mortgages become more affordable, demand is likely to increase as consumers who have put off buying a house since the rate increases began will be more inclined to enter the market. Overall, several factors continue to provide upward pressure on the US residential housing market which has proven to be incredibly resilient in the face of historically high interest rates.
