Latest / Inflation Explained with Fexingo: CPI, Prices, and the Cost of Living for Everyday People / The Inflation Gap Between Your Brokerage and Your Bank
Transcript
- Lucas: So the S&P 500 closed at 7,483 yesterday. That's up almost 2 percent just this week. The Nasdaq is at 25,833. Markets are celebrating. But if you've got cash sitting in a regular savings account at a big bank, you're probably earning... Luna: Let me guess: next to nothing. Lucas: Yeah, about 0.5 percent. Maybe. Meanwhile the Fed funds rate, the rate the Fed sets, is at 3.63 percent. The core PCE inflation gauge — the Fed's preferred measure — is at 3.4 percent. So there's this bizarre gap: stocks are hitting records, inflation is still well above target, and yet the cash in your bank account is barely keeping pace, let alone earning a real return. Luna: Right. And the Fed has been holding rates steady for months. The effective fed funds rate has been stuck at 3.63 since June. If the Fed is paying banks 3.65 percent on reserves they hold, why aren't banks paying us anything close to that? Lucas: That's the exact question. In economic theory, when the central bank raises rates, banks should pass those higher rates along to depositors. Otherwise, why would you keep your money in a low-yield account? But in practice, banks have become much slower to raise deposit rates. There's even a term for it: deposit beta. It measures how much deposit rates move in response to changes in the fed funds rate. Luna: And that beta has been falling, right? It used to be close to 1 — meaning a 1 percentage point hike in the fed funds rate would lead to a roughly 1 percentage point increase in deposit rates. Now it's more like 0.4 or 0.5. Lucas: Exactly. A paper from the Kansas City Fed a few years ago showed that after the 2008 crisis, the deposit beta fell significantly. Banks have more market power now. They know that many depositors are sticky — they don't shop around for better rates. So banks pocket the difference. They borrow from you at 0.5 percent and lend it out at mortgage rates around 7 percent or credit card rates north of 20 percent. It's a massive spread. Luna: And that spread is basically a tax on savers. Especially smaller savers who might not have the time or knowledge to move their money to an online bank or a money market fund. Lucas: Right. And that's where the disconnect shows up in the macro numbers. The S&P 500 at 7,483 — that's great if you own stocks. But the labor force participation rate just dropped to its lowest in 50 years, outside of COVID. And the June jobs report showed only 57,000 new jobs. The unemployment rate ticked up to 4.2 percent. So the stock market is cheering, but the average person might not feel that wealth effect if their savings aren't growing and their job prospects are uncertain. Luna: It's almost like two economies. One for people with assets, one for people without. Lucas: Yeah, and that's a big deal for inflation too. Because when the Fed raises rates, it's supposed to slow the economy by making borrowing more expensive and saving more attractive. But if the saving part isn't working — if banks aren't passing on those rates — then the transmission mechanism is broken. People keep spending because their cash isn't earning anything, so why not buy that new TV? Luna: So the Fed's policy is less effective than it should be. That could mean they need to keep rates higher for longer, which hurts everyone, but especially people with variable-rate debt. Lucas: Exactly. And that's the irony. The very banks that are benefiting from low deposit rates are also the ones that are supposed to be the conduit for monetary policy. When they don't pass through rate hikes, the Fed has to do more work, which means higher rates for borrowers. Luna: So what can a regular person do? I mean, besides moving money to a high-yield savings account, which not everyone does. Lucas: That's the obvious first step. Online banks and credit unions often offer rates closer to the fed funds rate. Money market funds are another option — they're yielding around 4 percent right now. But there's also a broader point: if you're not getting a competitive rate on your cash, you're effectively subsidizing your bank's profits. And that's a choice, even if it's not an intentional one. Luna: You know, speaking of choices that make a difference, this podcast itself is a choice we make to keep it ad-free. And we can do that because of listeners who support us directly. If walking through the economy with us has made something click, a couple of dollars a month genuinely makes a difference — it keeps these episodes coming without any sponsored interruptions. Lucas: Yeah, we really mean that. It's not a big ask. A few bucks covers hosting costs and our time. If you've gotten something out of the show, you can head to buy me a coffee dot com slash fexingo. That's all lowercase. We appreciate every single one. Luna: And honestly, it's what keeps us independent. So thank you. Anyway, back to that deposit beta — you mentioned the Kansas City Fed paper. What did they find exactly? Lucas: The paper quantified how the pass-through from market rates to deposit rates has weakened. In the pre-crisis period, a 100 basis point increase in the fed funds rate would lead to about an 80 basis point increase in deposit rates. Post-crisis, that dropped to around 40 basis points. The authors attributed it to increased market concentration and the fact that banks have a lot more excess reserves now, so they don't need to compete for deposits as aggressively. Luna: Meaning they can sit on piles of cash and not worry about losing depositors. Because where are they going to go? Another big bank that also pays 0.5 percent? Lucas: Right. The top four banks in the U.S. — JPMorgan, Bank of America, Wells Fargo, Citigroup — hold over 40 percent of all deposits. They don't need to compete on rate. So the little guy loses. And that's especially painful right now because inflation is eating away at the purchasing power of that cash. Luna: Let's put a number on it. If you have $10,000 in a typical savings account earning 0.5 percent, after a year you have $10,050. But with core PCE at 3.4 percent, the real value of that $10,000 has fallen to about $9,670. You've lost over $300 in purchasing power. Lucas: And that's before taxes on the interest. So it's a negative real return. Meanwhile, the stock market has been going up — the S&P 500 is up over 20 percent year-to-date. But not everyone has a brokerage account. According to the Federal Reserve's Survey of Consumer Finances, about half of U.S. households own stocks directly or indirectly. So half of households are getting that wealth boost. The other half — they're seeing their cash erode. Luna: And even among those who own stocks, the distribution is skewed. The top 10 percent hold something like 80 percent of the value. Lucas: Exactly. So when we talk about the economy, we have to remember that the averages can be misleading. The S&P 500 at an all-time high doesn't mean everyone's doing well. That's why indicators like the labor force participation rate are so important. It dropped to 62.4 percent in the latest data — that's the lowest since the 1970s, outside of COVID. People are giving up looking for work. Luna: And the jobs report showed only 57,000 new payrolls in June. Goldman had estimated the World Cup might have added 40,000, so underlying job creation was even weaker. Lucas: Yeah, the economy is definitely slowing. But inflation is still sticky. Core PCE at 3.4 percent is way above the Fed's 2 percent target. So the Fed is stuck: they can't cut rates because inflation is too high, but they can't raise rates much more because the economy is softening. And the deposit beta problem means their rate hikes aren't as effective as they'd like. Luna: So what's the way out? Do we just have to live with this disconnect? Lucas: Part of the solution might be competition. If fintechs and online banks continue to gain market share, they might force the big banks to offer better rates. We've already seen some movement — Ally Bank is offering around 4 percent on savings. But the big four are still paying peanuts. Another possibility is that the Fed could change its approach to interest on reserves, but that seems unlikely. Ultimately, the best defense for individuals is to shop around. Treat your cash like you treat your groceries — compare prices. Luna: It's a good reminder that in a world of 3.63 percent Fed funds, settling for 0.5 percent is a choice. Maybe not an easy one if you don't know the options, but there are options. Lucas: Right. And that's really the takeaway. The economy has these weird seams where the plumbing doesn't work perfectly. The deposit beta gap is one of them. Being aware of it is the first step to not losing purchasing power. Luna: Well said. And on that note, we'll see you next time.