Contrarian Interest Rate Theory

Click to enlarge.

The line in blue shows the 5-year CD rate at commercial banks (left scale).

The line in black shows wages and salaries divided by deposits at commercial banks (right scale).

Here's the theory.

A lender's ability to lend is generally determined by the amount of their deposits (fractional reserve banking notwithstanding).

A lender's desire to lend is generally determined by the stable income streams of the borrowers (NINJA loans notwithstanding).

When wages (a bank's desire to lend) grow slower than deposits (a bank's ability to lend), then all things being equal (which they rarely are), the interest paid on deposits should fall (clearly seen in the chart). It's simply supply vs. demand. Not enough wages. Too many deposits.

Unlike nearly every financial expert on CNBC, I am not a believer that we're in a rising interest rate environment over the long-term. Wage growth is not keeping up with deposit growth. There are no signs of that trend changing any time soon (as seen in the declining black line in the chart). Why would I expect higher CD rates when there is a growing wage famine (nonfarm payroll employment) relative to a growing deposit glut (CPI adjusted deposits)? As seen in the following chart, note that this is a new development that began in February of 2000 (the peak in wages divided by deposits). In hindsight, Y2Katasrophe for the win!


Click to enlarge.

Inflation (or the lack of it) isn't really going to alter the dynamics much in my opinion. Banks aren't going to pay higher CD rates just because food costs more. I would be the last to argue that they're nonprofit food banks (Jamie Dimon sarcastically notwithstanding).

This is not investment advice. If it was, I would have written this post in Japanese as a tribute to Japan's popping housing bubble in the early 1990s and 20+ years of its ongoing low interest rate aftermath.

Source Data:
St. Louis Fed: Custom Chart #1
St. Louis Fed: Custom Chart #2