WASHINGTON -- The stampede by investors to trade maturing certificates of deposit offered by commercial banks for higher-yielding bond funds may be coming to a temporary halt and may give a brief boost to the money supply, according to analysts at R.H. Wrightson & Associates Inc.
If that happens, money supply could get back into the Federal Reserve's target range of 2.5% to 6.5% by the end of this year -- a development that could remove some pressure from the Fed to lower interest rates further.
"The flight of funds from banks and thrifts has probably already peaked in the past couple of weeks," the firm's analysts say in their latest market letter.
Mutual fund managers and securities firms are aggresively marketing municipal and other kinds of bond funds in a bid to capture what some industry analysts say may be as much as $100 billion in bank certificates of deposit that are due to mature this month.
Bond funds have already grabbed billions of dollars in CD funds held by banks this year as short-term interest rates have tumbled and investors have reached for higher yield in longer-term securities. According to the latest report from the Federal Reserve, the rate on bank certificates in the week ending Oct. 9 was down to 5.21%, while Treasury three-year notes averaged 6.23%.
According to the Investment Company Institute, the trade association for the mutual fund industry, holdings of bond and income funds are up $79.6 billion through August, compares with a year earlier, said institute spokesman John Collins.
But the analysis by R.H. Wrightson suggests mutual funds and securities firms are going to run into stiffer competition from banks seeking to attract deposits during the fourth quarter.
"The banks will be setting rates at a level to compete better with the bond funds," says Louis Crandall, a senior analyst at the firm.
Federal Reserve officials have paid increasing attention to the rush by investors into bond funds because bonds are not counted as part of the broad M2 measure of money. The money supply as measured by M2 has been essentially flat since the summer, and for the year growth has been below the Fed's annual target range of 2.5% to 6.5%.
Bush administration officials have repeatedly expressed concern about the slow growth in the money supply, an indirect way of appealing to the Fed to keep lowering rates to try to stimulate the economy.
R.H. Wrightson, in its analysis, says much of the buildup in maturing CDs coming due this month reflects moves by investors to buy six- and 18-month instruments in April -- when income taxes must be paid -- for their Individual Retirement Accounts and Keogh accounts.
But, the firm concludes, "We doubt that the October bulge will have a discernable impact either on money supply growth or on flows into alternative investments."
The reason, the firm says, that banks in the fourth quarter will have to work harder to hold on to their deposits is that they will no longer be getting large inflows of cash from the Resolution Trust Corp. to compensate them for taking over deposits from the savings and loan bailout.
Government outlays to pay for deposit losses in the RTC-managed bailout totaled about $65 billion in fiscal year 1991, which ended Sept. 30. However, funds for the cleanup are largely exhaused, and Congress has not come up with additional funding -- the administration wants another $80 billion -- to complete the thrift cleanup.
"The RTC has plenty of deposits left, but it has run out of cash with which to compensate banks for assuming them," says R.H. Wrightson, which correctly predicted last weeks's recall by Treasury of 20-year bonds with 7.5% coupons.
"Congress does not even have a timetable yet for authorizing new bailout funds. The RTC cannot even open the bidding on failed thrifts until it is assured of funding, meaning that a one-month or two-month delay in approving new funds could mean a four- to five-month hiatus in actual bailout operations."
The firm said the bailout has enabled banks to scale back their offered rates on deposits and advertising for new customers because they could readily count on "a reservoir of RTC deposits." Although banks lost some deposits, they got a lower average cost of funds on what was left and could replace the losses by dealing with the RTC.
Moreover, the firm says, banks have not been weaponless in seeking to compete with other financial institutions for business. While maturing CDs with maturities of one year of less fell $16 billion from March to August, the latest period for which data are available, deposits of CD with maturities of over one year are up $23 billion in the same period.
"Clearly, banks have the products with which to compete with bond funds and unit trusts if they need to," the firm says.
By the end of the fourth quarter, money supply should be back in the bottom part of the Fed's target range of 2.5% to 6.5%, says Mr. Crandall. All things being equal, that should take some of the pressure off the Fed to lower interest rates, he adds.
However, he warns, Congress is expected to resolve the RTC funding issue eventually and resume pumping money back into the commercial banking system, "so want we're saying is about flows [of money] in the next few months."