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Cash can only be king when its palace is secure. Nothing agitates the markets quite as much as the news of failing banks, given how conditionally the financial system relies on confidence and confidence alone. From the likes of the Silicon Valley, Signature, and First Republic banks in the US, to Credit Suisse across the Atlantic, investors who have been in the market long enough would feel an eerie chill reminiscent of the years leading up to the GFC in 2008. Yet it isn’t just risk-adept investors feeling the nervousness; even risk-averse depositors are taking strides to ensure that their savings are not under threat from a banking crisis. Notably, 2023 saw the largest year-on-year drawdown in US commercial bank deposits (less the stickier large time deposits) in decades, dwarfing even that of the 1981 Volcker-era decline.
Figure 1: 2023 bank run is the worst deposit y/y drawdown since the Volcker era
Source: Bloomberg, DBS
From bank run to bank sprint. While it is easy to blame the banking crisis for the dearth of confidence, the data shows that the acceleration in deposit outflows had already begun months before the bank failures over the past weeks. In the age of proliferation of banking and investment mobile apps, along with broader virality through social media, bank runs become more like bank sprints. Case in point – Washington Mutual failed when depositors attempted to withdraw c.USD17b in deposits over nine days in 2008. That same amount was gone from Silicon Valley Bank within just half a day.
Figure 2: Money flowed from deposits to Money Market/Quality credit funds
Source: Bloomberg, EPFR Global, DBS
Where has all the money gone? Yet money can’t just disappear. Flow of funds data showed that the markets have flocked towards cash-proxies – either with Money Market funds or high-quality, short duration credit funds. If that sounds familiar, it is because that is precisely the premise of our Liquid+ Strategy – that investors are better off being well-diversified in safe and liquid assets as the world navigates a tricky environment of stubborn inflation , slowing growth, and rising uncertainty . We see the flow of funds data as affirmation that we are not alone in this line of thinking.
Figure 3: Cash deposit rates lagging far behind other safe alternatives
Source: Bloomberg, FDIC, DBS
Go with the flow. This flow of funds from deposits to fixed income could still have legs. As we stand, such safe alternatives are yielding between 4-5%, a far cry from the average rates on jumbo deposits of 0.5-1%, according to the US Federal Deposit Insurance Corporation. The moment the market realises that we are nearing the end of the rate hike cycle, the demand for longer duration fixed income assets would surely accelerate the flows that we are already seeing in the markets over the last several months. It might be true that deposit rates would rise in tandem to compete for demand for funds, but as we are already seeing signs of banking stress, such higher deposit costs of funding would hurt bank profitability, which does not instill the confidence from depositors that they should remain concentrated in their exposure to the financial sector, given the stresses that banks are already facing today.
Stay with the Liquid+ Strategy. The track record for markets trying to perfectly time peaks and troughs is abysmal. As such, rather than trying to catch the peak in interest rates to fully switch into fixed income, we believe investors should start to progressively switch excess liquidity into these cash alternatives in order to (a) obtain a higher yield while they are available, and to (b) diversify away from concentration risk in bank deposits while the financial sector faces strain. As they say, better late than never.
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