Massive Corporate Slack
We have discussed the possibility of a lower IOER for some time now. Ever since the ECB
went to a 0 deposit rate, and the Danish went to a -20bp deposit rate, the Fed's policy of a
+25bps IOER has become increasingly suspect. The NYFED, and those associated with
large commercial banks, have written apocalyptic research pieces associated with a lower
IOER. And of course that makes sense; 25bps on 1.6 trillion in reserves is 4 billion dollars
per year. No money center commercial bank wants to lose that subsidy while the rest of us
non-bank mortals are forced to buy T-bills at single digit yields.
But there is something far more important than the bank subsidy in this IOER debate - the
corporates! Below are 2 charts. The first is a history of non-financial corporate "liquid"
deposits, broken down into checkable deposits, time deposits and MMMFs. Since 2000 the
total has risen from 600b to 1.4 trillion - that is a lot of "jack" on the sidelines. The second
chart however is more interesting. Here we see a history of those deposits since 1945 as a
percentage of GDP. The last time non-financial corporate deposits as a percentage of GDP
were this high was during WW2. And any chart that is back to its WW2 highs is worth a
gander!
So what does it mean? Well, in simple terms corporate defensiveness is basically the same
as it was during WW2. Accordingly, it would be safe to infer that many corporates are pretty
freaked out - and even near 0 rates are not spurring activity and hiring. Corporates would
rather earn zero nominal returns, and guaranteed negative real returns, on a large chunk of
capital instead of taking a risk. The good news is that lower rates have allowed most
corporates to refinance debt, which in turn has improved their earnings, balance sheet and
equity valuation. But there has not been any meaningful spending from these savings. Sadly
corporates are still waiting for the consumer to come back to life. But given that 69 percent of
homeowners still fund their mortgage at a rate above 5 percent, thanks to Ben's terribly
inefficient and inequitable distribution of monetary stimulus, it will be a long wait.
The fact is that there is a HUGE amount of corporate slack in the system, nearly 10 percent
of GDP looking for something interesting to do. The question is - where will it go? Many folks
are focusing on the expiry of deposit insurance at the end of 2012. The story goes that these
deposits will leave banks (and MMMFs) and head to securities. Back in 2006, securities plus
mutual fund holdings at non-financial corporates were 450b, and now they are 360b. So
maybe there is a trade here short term; and it is yet another reason to load up on a leveraged
position in front end UST securities. But the bigger picture is the amount of corporate slack. A
lower IOER would get corporates off the fence - hiring and investing. At the moment we have
a chicken/egg problem in the US economy. Businesses don't want to expand and hire
because sales are light and the consumer is weak. But the consumer is weak because job
prospects are low and the Fed forgot to get them a lower funding rate on their mortgage. We
have not been able to get lower mortgage funding rates to households, but we could start to
incentivize more hiring and investing at corporates by making deposits more expensive to
hold. Isn't that how monetary policy is supposed to work?
Buying MBS, expanding the Fed balance sheet, increasing inflation expectations and
lowering real rates is too subtle for the nominally challenged non-financial business world.
The IOER is very transparent - if you sit there and do nothing with your capital you will lose!!!
This is a very potent tool for generating the next virtuous cycle of expansion, job creation and
growth. Let's not let a few TBTF institutions get in the way of the most powerful weapon in
the Fed's war chest! Good luck trading.