By Dr. Dan Geller, Executive Vice President
Every year, Dr. Dan Geller, Market Rates Insight’s chief analyst, provides a prediction of deposit trends for the coming year. Attached is the first in a series of articles with this year’s forecast.
Expect 2012 to be a gray swan year; a year in which we know a risk is plausible, but we don’t know how it will impact the financial and banking industries. Unlike a black swan, which is a highly improbable and unknown risk, the gray swan of the banking industry is the financial faith of the European Union, which is made up of 27 member countries, especially the 17-member Eurozone countries. Although the U.S. exposure to the EU from a trade balance is only about $140 billion, the real risk is with the banking industry.
Continued turmoil in the Eurozone in 2012 is very likely to impact the financial and banking markets in the U.S. because of the interdependence of the global banking system and its reliance on the LIBOR (London Interbank Offered Rate), the world’s most widely used benchmark for short-term interest rates. LIBOR is the rate at which the world’s banks borrow money and is fixed on a daily basis by the British Bankers’ Association based on an average of interbank deposit rates for larger loans at the world’s most creditworthy banks.
One possibility is that money supply in the EU will tighten, causing the LIBOR to go up due to limited money supply. Higher LIBOR is very likely to impact borrowing interest rates in the US. because when banks borrow at a higher rate, they pass the increase in their borrowing cost to the consumer.
Another option is that LIBOR will decrease as a result of over liquidity due to increased money supply in order to stimulate the EU economy. Such a scenario is likely to put even greater pressure on net interest margins, causing deposit rates in the U.S. to go all the way to near zero.
Current indications are that the LIBOR is trending up as a result of the economic and financial status of the EU. The average LIBOR rate, which consists of the average of the 1, 3, 6 and 12 months rates, rose to 0.60% this November compared to 0.43% in April of this year - an increase of 40% in seven months. Historically, LIBOR rates and U.S. deposit rates have been highly correlated, which is the result of the inner dependability of the global financial world.
The instability of the EU financial system is a result of two main factors, one systematic and one cyclical. The systematic factor is the European sovereign debt crisis, which was caused by runaway government spending in some European countries. For example, Greece, Portugal and Italy all have elevated debt-to-GDP ratios, which when coupled with the second factor, the burst of the housing bubble in Europe, made it even harder for these countries to grow their economies.
Economic growth is a must in order to reduce and stabilize debt-to-GDP ratios, especially for countries like Italy, which has nearly €2 trillion in outstanding government debt. Moreover, Italy has slim growth prospects in the near term because it first needs to reform its labor market in order to increase productivity and become more competitive. Similarly, yet less drastic is the situation that exists in Spain, Gre
ece, Portugal and Ireland.
Since “organic” economic growth is not very likely in the short term for these members of the EU, the only two options left are default on their government-issued bonds, or to receive financial assistance from the ECB (European Central Bank), to support the Italian government bond market until stronger economic growth begins to take place. Just to put things in prospective, Italy is the 8th largest economy in the world measured by GDP.
In addition to, or because of, the uncertainty caused by the financial events in the EU, we have another unknown in 2012 – the direction of deposits APY and balance. Yes, generally speaking, APY has been on the decline in the past four years, and deposit balances on the rise. But a look at the rate of increase and decrease indicates that the year-over-year variance has wide fluctuations, which makes yearly projections somewhat challenging.
For example, the decrease in APY in 2011 was 36% less than in 2010, and conversely, the balance increase in 2011 was 300% greater than in 2010. Hence, it’s not just that we don’t know which way balances and APY are headed in 2012 due to the uncertainty of the financial crisis in the EU, we don’t even know the extent of the change once it occurs.
The best advice I have to offer is borrowed from Nassim Nicholas Taleb, the author of the Black Swan - when you can’t predict; be prepared. In other words, at this point we don’t know if the financial crisis in the EU will trigger a rate hike or push rates farther down. But, we can be prepared for both scenarios. The best
way to be prepared is to keep a close eye on deposit rates, and to develop two pricing scenarios; one for rate increase, and the other for rate decrease.
Subscribe