High Yields Are Great for Savers but a Problem for Everyone Else

Money market funds offer risk-free returns on cash, which spells trouble for banks.

High Yields Are Great for Savers but a Problem for Everyone Else

Savings can finally earn interest on their deposits. This is causing problems for nearly every other market sector.

Savings have been low or non-existent for most of the last 15 years because the Federal Reserve has kept interest rates at zero. These low rates kept bank funding costs low. The low rates made it difficult for depositors to transfer their cash because they were unlikely to find a higher return without taking more risks.

Over the last year, the Fed has raised its federal-funds target rate nine times. It went from near zero to a range between 4.75% and 5%.

This sudden rise in bond prices sent shockwaves through the equity markets. The sudden rise in financing costs ate into the profits of businesses.

At first it appeared that banks were enjoying a boom. The banks were able charge higher interest rates for loans while still paying the same for deposits. Customers were not motivated to move their money from one bank to another, or to another asset class for a small increase in return.

Two factors have changed that logic. Money-market account rates are close to 4%. It is therefore worth it for customers to transfer money from savings accounts, which offer little or no interest. The recent collapse of Silicon Valley Bank, and Signature Bank, has prompted a fear for the survival of banks. This is a good reason for depositors to move their money.

Charles Schwab's (ticker:SCHW) wealthy clients are moving their money from sweep accounts with low returns to CDs and Money Market Accounts. In mid-March, the firm claimed that it had ample liquidity as well as a diverse base of depositors.

Citigroup analysts expect money-market funds to account for 41% cash balances in Schwab by 2021, up from the 32% of the fourth quarter in 2022 and the 16% of the first quarter in 2021.

Citigroup analysts noted Wednesday that the net flow of money to money market accounts has decreased by over $1 billion in the last week.

The increase in money market fund balances is not limited to Schwab. According to Torsten Slok's data, chief economist of Apollo Global Management, the money in money market funds has increased by about $400 billion over the last year to just under $5 trillion. He found that in the week ending March 17, over $100 billion was invested in money-market funds.

This spells trouble to other financial assets. Stocks and bonds become less appealing when savers are able to earn a return.

Savita Subramanian is an equity and quantitative analyst at BofA Securities. She wrote on Wednesday that cash offers 5% return, which makes it a compelling alternative for the S&P 500. This is especially true given our year-end goal (S&P 4000), which suggests limited near-term gains. Subramanian, a quantitative and equity strategist at BofA Securities, found that households tend to reduce their stock allocation once cash can earn more than 4.5%.

Subramanian said that the outlook for bonds was not much better. He cited a 'euphoric sentiment' for the asset class, even though the Fed and China are no longer the two largest historical buyers of U.S. Treasuries.

Cash is king for now. Especially when it returns more than 4% and with a high degree of certainty.

Even savers should be cautious. Banks will raise rates on customer accounts when they see that there is a possibility of losing deposits. This increases their funding costs and makes them less likely to offer loans with favorable terms. In the January Senior Loan Officer Survey, the Fed found that banks tightened their lending standards in the fourth quarter before Silicon Valley Bank or Signature Bank's troubles were widely known.

If savers become borrowers, it is possible that they will realize higher rates have a double edge.