On Money & More – May 2023

“The Fed will keep raising rates until something breaks!” is an often-repeated Wall Street axiom. Well, this past quarter when Silicon Valley Bank (SVB) failed, something broke. But can it be fixed?

The stress in the banking sector is not entirely surprising. Nearly all of us are aware that our bank accounts are paying next to nothing in interest, while we are simultaneously aware that interest rates everywhere else have been going up. Something in this case had to give, and Americans have moved their cash out of bank accounts into money market funds en masse. In fact, year to date through March, about $460 billion has moved into money market funds (source: Bloomberg). Why don’t banks raise interest rates to compete better with money market funds? The easiest answer is that they make more money by not raising rates. Yes, a lot of deposits are leaving, but those that stay will remain very profitable for the bank.

While raising the interest rates in savings accounts may be unappealing for banks, what they will do when stressed is curtail their lending. In the past two weeks of March, lending from US banks dropped by over $100 billion (source: Federal Reserve). This record-setting level of tightening will reduce economic activity, and ultimately contribute to lowering inflation. So, is that it? Is the Fed done? Not so fast! SVB, and other banks that have failed, were particularly mismanaged banks. As the dust has settled, the resiliency of the US economy, as well as the banking system, has taken over the narrative. The Fed had enough confidence to raise rates another 0.25% in March and is currently forecasted to raise yet another 0.25% in May (and then, hopefully, pause). While the Fed did raise rates until something broke, inflation remains their utmost priority. This past October, Federal Reserve President Mary Daly stated, “We definitely don’t raise rates until something breaks; we actually are forward-looking.” Turns out, this may be true on this go ‘round.

For investors, this situation has created some opportunities. Usually, we advise against following the herd, but when it comes to moving your cash into money market funds, we say “go for it!” With another potential rate increase on the table, it’s possible that these money market funds will have a yield around 5%, a rate cash investors haven’t seen for years. Short-term treasury bonds and for those that may want to keep their money at a bank, CDs, are also attractive cash alternatives for investors.

What about opportunities for equity investors? While there are plenty of storm clouds surrounding the banking sector and the economy, we don’t invest in the equity markets for short-term returns. Money market funds may have a great yield today, but as inflation pressures wane, their rates will likely come down. Equities have historically outpaced cash and bonds, albeit with a much different risk profile. As such, our advice would be to maintain a portfolio that has been constructed to best position you for your goals but also to get that cash to work asap!

All opinions and data included in this commentary are as of April 10, 2023 and are subject to change without notice. The opinions and views expressed herein are of Cutler Investment Counsel, LLC and are not intended to be a forecast of future events, a guarantee of future results or individual investment advice. Nothing herein should be construed as tax advice. This article is provided for informational purposes only and should not be considered a recommendation or solicitation to purchase or sell securities. This information should not be used as the sole basis to make any investment decision. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Investing involves risk, including the potential loss of principle. Neither Cutler Investment Counsel, LLC nor its information providers are responsible for any damages or losses arising from any use of this information.