While it’s a little early (just 69 banks have reported so far), the pace of Net Interest Margin (NIM) contraction appears to be slowing as we had anticipated. Chart 1 displays the path of NIMs over the last four quarters on a consistent cohort basis of the 69 banks that have thus far reported, with each line representing the distribution NIMs for that quarter.

In listening to the earnings calls of the banks that have reported, there is a growing narrative that NIM pressures are easing, and guidance reflects an increasing though measured sanguinity regarding the ongoing rate pressures. We are not so sanguine.

We don’t see reason enough yet to expect NIMs to improve meaningfully in the near term. Nor do we believe that the deterioration is over.

I’ve heard several bank analysts on Bloomberg or CNBC say something like, “Deposit costs usually peak one or two quarters after the Fed Funds rate peaks.” That may have been true of previous rate cycles but only because of the particular characteristics of those cycles.

For instance, the last rate cycle where we saw Fed Funds rates of 5%¹ or more began in 2Q04 after the Fed Funds rate floored at about 1%. It rose for the next 10 quarters peaking at 5.25%. It remained above 5% for only the next 4 quarters leading into the GFC. The total time between rates beginning to rise then beginning to fall was about 13 quarters.

We are only 7 quarters into the current rate cycle. So, while the rate ascent was far quicker than the previous cycle, which serves to push funding costs up faster, we may stay near peak rates much longer than in the previous cycle. The implication is that while the pace of increase in funding costs may have slowed, if rates remain high, funding cost will continue to grind higher while loan rates will reach their far quicker. The result is that NIMs will continue to contract so long as rates remain high.

As can be seen in Chart 2, deposit rates are nowhere near where they were last time Fed Funds rate was above 5%. It’s also clear from this chart that the pace of change slows once rates peak; but it does not stop until rates begin to fall. The simplest explanation why deposit rates are still so low is that while rates are high enough, they haven’t been high long enough.

1. These are quarterly average Fed Funds rates. ↩︎