There is no US deposit flight

Good morning. Did Silicon Valley Bank’s poor asset-liability management prompt Saudi Arabia to drill less oil? That’s how we read this line in the FT, from the energy analyst Amrita Sen: “Opec+ have made a pre-emptive cut to get ahead of any possible demand weakness from the banking crisis”. If you can think of an odder chain of events than that, email us about it: [email protected] & [email protected].

Deposit flight is not a big deal for US banks

A fair amount has been made recently of deposits leaving US banks, mostly heading for money market funds, which are perceived to be safer. Late last week the FT reported that:

US money market funds reported net inflows of $66bn in the week to March 29, as investors continued to seek alternatives to bank deposits . . . 

The funds had net inflows of more than $100bn each of the prior two weeks after the collapses of Silicon Valley Bank and Signature Bank. The inflows are going mainly to super safe government funds

On Friday, US deposit data for the week ended March 22 — that is, two full weeks into the banking micro-panic — was released by the Federal Reserve. The numbers broadly tallied with the money market inflows: deposits at domestically chartered commercial banks are about $221bn lower than a month ago. This is real money. But there is an important piece of context to keep in mind. There are 16 trillion dollars of deposits in domestic banks, and that figure has been falling slowly since last spring. Here’s a chart of what deposits have done since the start of the pandemic:

US bank deposits are a third higher than they were at the start of 2020, which makes worries about a banking system liquidity crisis seem a little overwrought (though, to be fair, it is changes in liquidity, not absolute liquidity levels, that matter most to markets).

There is a little notch in the pink small banks line, all the way at the right, and if you convert the chart into 4-week per cent change, you do see a change in trend there:

So there was a one-time outflow of about $185bn, or about 3 per cent of small banks’ deposits. The next week, however, small bank deposits were stable. With the usual qualifiers — things can always go wrong later, and so on — US banks do not seem to have a deposit outflow problem.

The problem we worry about (to return to a theme we have banged on about for some weeks now) is not deposits flows but deposits costs. The concern is that until a few weeks ago businesses and households were doing what they usually do, and sleepily ignoring the rate they were earning on their bank accounts. Then stupid SVB went and woke everyone up. Already, deposit rates had been rising slowly (from roughly nothing), and may accelerate now, crimping bank margins even as the economy slows. This is data as of March 20:

As we’ve been saying: the US banks have left the emergency room and can go home. But they have picked up a chronic disease — lower profits — that will require monitoring.

EMs: pain now, gain later

“Emerging markets” is an awkward label, based on the pretence that stocks in a diverse set of countries can be invested in as a single asset class. But, as the saying goes, what gets measured gets managed. The EM value proposition is supposed to be: accept big risks like exposure to US monetary policy and commodity prices, and get additional upside and low correlations.

As a whole, however, EMs have been a lousy place to park your money in the past decade:

This has spooked global investors, leading many to slash EM holdings. In a recent paper, Michele Aghassi and Dan Villalon of AQR Capital Management look at EM weightings across Nasdaq’s eVestment database of institutional funds. They find portfolio managers allocating 9 per cent to EMs, compared to the 12 per cent allocation you’d have just buying the MSCI World index.

There’s reason to think this is overdone. A sluggish decade aside, EMs really have had periods of outperformance, and have kept up with US equities over the last two decades (which have been great for US equities):

Over the very long run, EMs live up to their high risk, high return reputation. According to the 2023 Credit Suisse Investment Returns Yearbook, EMs have had higher high years and lower low years than global equities. Average real returns since 1900 are comparable in both categories, though EM geometric-average returns are much lower (3.8 per cent for EMs versus 5 per cent for world equities), reflecting the lingering performance drag of sharp losses.

This is all to say: maybe a bad decade is just a bad decade, and not a reason to think EMs will stink forever. In any case, out-of-vogue investments can offer enticing entry points. At 12 times forward earnings, the MSCI EM index looks inexpensive on its own terms and even cheaper relative to US stocks:

AQR’s Aghassi and Villalon argue that EMs’ cheap valuations seem more like underpricing than compensation for rising risks:

Emerging markets historically have been riskier than developed markets, but that difference has come down over the past decade — both in terms of standalone index volatility and in terms of correlations .

Over the past 20 years, per capita GDP in emerging markets has roughly doubled as a share of developed markets. Measures of external vulnerabilities have also improved from their periods of peak fragility in the 1980s and 1990s. Current account balances in emerging markets are now positive in aggregate, and measures of external debt sustainability (eg, external debt as a percentage of exports) look much healthier.

Bottom line: there are many reasons to believe that the relatively attractive valuations found in emerging markets represent a 5-10 year opportunity.

This is not the formula for a short-term rally, obviously. Indeed, the short term looks messy, as chief economist Ludovic Subran and his team at Allianz pointed out in their recent quarterly outlook. Their view, in sum, is that it is tough to own EMs when financial conditions are tightening and, despite the prospect of Fed easing, further tightening is the central forecast worldwide:

Monetary policy space will remain limited in 2023-2024, with inflation subsiding moderately but remaining sticky and thus above central banks’ target range in most EMs . . . Most EMs, especially commodity importers, also face a lack of fiscal space owing to pandemic-related support measures that have stretched public finances, as well as significantly increased financing costs . . . Although the downward adjustment in Fed interest rates would in theory provide some relief for EMs (in the form of a weaker USD and some space for cuts), the fact that it has been triggered by banking stress episodes has the opposite effect and could spark liquidity shortages

They provide this illuminating chart of international flows into emerging markets plotted against the Chicago’s Fed’s financial conditions index. As conditions tighten (the blue line rises) flows tend to reverse (the multicoloured columns): 

Speculating on emerging market equities’ short-term performance is for people who are either way smarter or way stupider than us. But the case for maintaining a modest but significant allocation to them appears pretty solid to us. (Wu & Armstrong)

One good read

Great data visualisations from John Burn-Murdoch about the shocking fall in US life expectancy, with a focus on the terrible suffering of the young and poor (a complimentary geographic perspective can be found here).