U.S. banks slow bond market liquidity deployment as deposits fall in second quarter

Even in the face of higher interest rates, banks were reluctant to invest cash in the bond market in the second quarter of 2022 as deposits declined over the period.

Banking stocks fell 1.8% from the prior quarter as excess cash declined over the period, with loans up 3.7% from the related quarter and deposits down 1.9%. %. As a result, bonds fell to 25.9% of assets from 26.1% in the previous quarter, according to data from S&P Global Market Intelligence.

Bank investment slows as liquidity pressures emerge

Banks stepped up bond-buying activity after the onset of the pandemic as government stimulus measures and accommodative fiscal policy left them awash with deposits. But banks deployed less liquidity in the bond market in the second quarter as high inflation and the Federal Reserve’s efforts to control it through tighter monetary policy began to put some pressure on liquidity.

The Fed raised short-term rates an additional 175 basis points in the second quarter through a series of rate hikes in April, May and June and began shrinking its balance sheet at the end of the period. The central bank raised the target federal funds rate by 75 basis points in July, and federal funds futures suggest another 75 basis point hike is in sight at its September 21 meeting.

Medium and long-term rates followed the rate hikes, with average 2-year, 3-year and 5-year Treasury bond yields rising more than 110 basis points in the second quarter compared to the first quarter. These yields continued to rise in the third quarter.

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Banks continued to allocate less cash to the long end of the yield curve in the second quarter, recognizing that the value of these securities could come under greater pressure as rates rise. Bonds expected to be repriced or mature in more than 15 years almost fell to 33.8% of securities held by banks in the second quarter, from 34.6% in the previous quarter and 36.2% a year ago. year.

Banks are deploying more cash into shorter-term investments

While total holdings declined in the second quarter, banks continued to increase their exposure to the front end of the yield curve over the period. Securities scheduled to mature or reprice in less than three years rose 2.5% in the second quarter from the prior period. As positions increased, shorter-term securities rose to 23.4% of total securities, from 22.4% in the prior quarter.

Rate hikes put pressure on the values ​​of many bonds held by banks in the second quarter, weighing on tangible book values. Short-term and intermediate rates have risen since the end of the second quarter and many banks have chosen to invest more funds in short-term securities to avoid this pressure and maintain access to these funds earlier in the event of a crisis. accelerating pressure on liquidity.

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