There is a mini bank run taking place and this may just be the beginning … Banks are taking advantage of their loyal customers by not paying them a dime on their deposits …
Meanwhile, they earn over 3% on the reserves they park at the Fed as a requirement against the deposits they hold …
Well, for the past year those deposits have shrunk by $1.2 trillion and that may accelerate as rates continue to rise …
This is raising a huge red flag and could have massive ramifications for market liquidity and the ability of banks to take risk.
Today I’ll lay it all out for you and on Wednesday if you attend my post-Fed meeting live event at 4 pm…
- I’ll give you details on what Powell said
- What I think he will do
- Plus give you two trades that will capitalize on a shift in policy.
When Fed Policy is brought up the discussion is usually directed to the Fed’s quantitative tightening program (QT) … This program drains money from the banking system and so far, the Fed has drained $200bn.
The Fed’s plan is to drain $1trn from the system per year … The main issue for investors is exactly what is contributing to that drop …
The drop in assets is due to the Fed allowing Treasury bonds (USTs) and Mortgage-backed securities to roll off the balance sheet as they mature without reinvesting proceeds.
However, as their assets are run down it also reduces:
- Currency in Circulation
- US Treasury General Account (TGA)
- Bank Reserves held at the Fed
- Reverse Repo Facility
Currency in circulation is the most stable item because it represents the demand to hold physical cash so as the trend is to a cashless society it does not fluctuate much.
Currently, the TGA has $600 billion in balances as higher tax receipts flowed back to the government post-Covid relief programs and it does not fluctuate much either …
Reverse Repo and Banks Reserves is Where it gets Interesting
US banks currently hold customer deposits of under $3 trillion … Bank deposits are down dramatically from $4.3 trillion because they pay their customers nothing for them.
In this environment where the banks have the risk of loan defaults, they look to maximize their return on equity and pay 0% interest on deposits to pump up margins.
What banks don’t realize is there are better alternatives for customers and their “free” deposits may shrink much further.
As you can in the chart below … returns on the Bank Reserves held at the Fed, and money market funds (MMF) offer decent returns as opposed to 0% for depositing money at a risky bank.
The Fed data lags real-time data so actually the current rate is above 3% and post the Fed meeting on Wednesday households will be able to earn 3.75% by investing in risk-free Treasury Bills or in Money Funds backed by USTs.
This means deposits at banks could fall a lot further …
Lose Deposits … Lose Reserves
Here is the important point …
When deposits are withdrawn from a bank, they must remove the liability from their private sector deposit entry and remove the asset from their bank reserves entry.
Banks’ loss of reserves means they are losing real money because reserves allow them to:
- To settle interbank payments
- Engage in repurchase agreements (Repo) and
- Even buy riskier bonds from other banks.
Most importantly a large number of reserves in the system adds plenty of liquidity for the collateralized loan and borrow market (Repo) that greases the gears of the entire financial system.
The Banks will be big losers as a mini-run on deposits hits profit margins.
Who Wins?
Money market funds will be the big winners as their assets under management (AUM) increases … They can simply deposit that growing AUM in the Fed’s reverse repo program (RRP) at over 3%.
Notice the graph below showing the RRP balances picking back up in the past few days …
Bring It Home
This is a very important development to keep an eye on … Could the Fed purposely be trying to reduce the bank’s participation in the real economy?
Yes, because a central bank digital currency (CBDC) eliminates the need to go through the banking system to inject real money into the economy.
However, that may be years away, and in the meantime …
Lose deposits … Lose Reserves … Losing direct economic stimulus into the economy … Doesn’t sound like a good recipe as the economy heads toward recession …
This may be a factor in Jay Powell’s policy response on Wednesday …
So join me at my live Power Income Trader event at 4 pm on Wednesday … I will give you all the details on what Powell said and more importantly what he will do and the impact it will have on the markets …
I will also give away 2 exclusive trades to all who attend … Don’t miss it …
Until Then …
Live and Trade With Passion My Friend,
Griff