Cash is King
As everyone reading this is well aware, we have for a very longe time, (including the first 6 and a half years after we founded Origin), been in a ZIRP environment. Within the world of fixed income, broadly, the problem facing market participants was too much cash.
I recently read a brilliant article on “the return of cash”, and I thought it might be worthwhile to explore this topic in more depth.
Too much of a good thing
In recent years, corporates had a lot of cash as they could borrow at record low interest rates. And banks had a lot of cash because their corporate customers were parking the cash in deposit accounts with them.
It eventually got so bad that having cash actually cost money, especially as the ECB pushed rates down into negative territory. That fed through into the money markets, with many banks actually charging customers to hold EUR deposits.
The tables have turned
Now, the tables have turned. Banks are ratcheting up the interest rates they charge on lending products (loans, mortgages etc) and earning bumper profits because of it. And they’re scrambling to build up their cash bases.
Consumers are moaning that while mortgage rates go up, savings rates haven’t followed. But these things do obviously tend to lag, and competition in the high yield savings market is heating up. A quick look at MoneySuperMarket and you can see 1y fixed-rate savings bonds yielding 4.5%! Compared to what we’re used to seeing, that’s a huge jump.
Cash balances are falling
What is more interesting is to see news that cash balances on corporate balance sheets are starting to go down. This is unsurprising – they reached a record high during the pandemic when rates hit rock bottom, but with rates going up, corporates are likely to be more hesitant to refinance their debt at today’s higher interest rates.
So that spare cash is going to be used to cover near term maturities. What could be more worrisome is if cash is used for “irresponsible” activities like share buybacks, leaving balance sheets strained as we head into a recession.
A new way of doing business
So, what does that mean for the debt markets?
Firstly, individual investors are going to care about fixed-interest investments a lot more than they have in years past. In previous years, one could get away with an attitude of, “everything yields 0%, so I’ll just let everything sit in my current account…and maybe buy an NFT every once in a while.” But with inflation topping 10%, and better alternatives now showing up, that complacency on cash yields and short term savings will no longer hold.
Secondly, this means that bank funding is going to get a lot more interesting in both the retail and the wholesale space. Stretched consumers and corporates wary of the bond market are going to lean on their banks to help them get through this period. This means banks will need to bolster cash balances - expect to see deposit rates go up, as well as big increases in bank debt issuance.
Thirdly, and this is a slightly bold prediction, maybe we start to see the return of retail bond issuance? We have investment grade issuers on Origin paying over 5.5% in 1y GBP…and over 7% in 1y USD! Given the first point about current account yields, suddenly, that doesn’t look bad compared to even high yield savings accounts.
As Keynes once said, “When the facts change, I change my mind.” The zero rate zero inflation world is over. Time for all of us in the bond market to prepare for a new way of doing business.
