The Best Places to Put Your Cash During the Banking Turmoil‍

There are opportunities to be found amid the banking turmoil roiling markets as T. Rowe Price's fixed-income group, led by Cheryl Mickel, oversees money markets, short-term taxable bonds, and stable value investments. Mickel, who is responsible for the fixed-income group, knows where the opportunities lie during the chaotic period.

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According to Mickel, T. Rowe Price’s U.S. Taxable Low Duration Group, which oversees more than $100 billion in assets, it is yet to be determined whether the recent troubles involving U.S. regional banks and a few European giants will lead to a widespread crisis. The team of Mickel, however, is looking for opportunities to lock in higher yields rather than hunker down.

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As the markets have experienced some of the most extreme swings in two-year bonds in decades recently, a recovery in this market is now on the horizon. This market has taken a beating in 2022, as it has led to cash and short-term bonds yielding attractive yields for the first time in a decade.

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Prior to the Federal Reserve's 25-basis-point hike, we interviewed Mickel, one of Barron's 100 Most Influential Women in U.S. Finance, and contacted her again via email on March 24, to discuss the best places to park cash for a year or two, banking tips, and where the Federal Reserve could go next. Here is an edited version of our conversation.

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I wanted to ask you what you thought about the remarks that came out of the Federal Reserve after its recent hike in interest rates by a quarter point?

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Among the things I am most impressed with is [Fed Chairman Jerome] Powell's directness in stating they will raise interest rates again, if necessary, and acknowledging that the banking crisis is still unknown as far as its impact is concerned. Despite the fact that the Fed was extremely transparent in his remarks about the banking system’s concerns, they have not been able to convey to the markets an effective narrative of bolstering confidence. Markets are not yet embracing this narrative, which may be difficult for them to convey effectively. Several large banks, including Deutsche Bank DBK +2.20% and Citigroup are experiencing elevated flows out of deposits, which is putting a strain on funding for smaller banks, and there are concerns in the market surrounding other large banks such as UBS MU +2.20%. One wild card is the extent to which the banking crisis limits credit growth.

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Were we in a full-scale crisis at the end of last year?

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As a matter of fact, we're currently facing more of a test of market confidence right now. The market isn't quite convinced that there is still strength in the economy and in the banking sector, and it is not willing to believe that there is still some resilience.

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Compared to past crises, this particular "crisis" is quite different. A lot of regulation has been implemented to build resilience so, in aggregate, banks are in a much stronger position than they were during the [2008-09] global financial crisis. Moreover, government support has begun earlier, has been practiced, has been more targeted, and does not deal with capitalization issues of the past.

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Clearly, that's the rational position, but all the assurances of resilience in banking systems around the globe aren't taking hold yet, which gives fissures and cracks more time to deepen and break.

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In what ways does that impact your choice of property?

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It is important to be on high alert when the market moves, because hedges and positioning that are off sides can cause unforeseen havoc. The ZIP Code where we start has higher rates, so there is a lot more cushion than we had a year ago, so we have been conservatively positioned.

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Do you have any concerns about any particular areas?

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A lot of midsized banks deal with commercial real estate, so they should use caution there, as well. Smaller banks are experiencing more funding pressures, so we advise caution in that sector as well.

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There are pockets of opportunity that are dislocated. All yields are not the same, so we are looking for credit that is strong and can weather a period of volatility. Every company we evaluate is compared to the broader market, and we are looking for businesses with strong business models and cash flows that can weather the volatility. Basically, what we are looking at here is how the banks are positioned to withstand volatility in the market by assessing their ability to withstand a run, how their assets are managed, and how they can differentiate between specific companies based on how they are positioning themselves.

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Can you give me an example of an opportunity that is attractive?

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In my opinion, it is important to not simply assume that all regional banks are bad places to be. In fact, it simply isn't true. There are some trust banks and quality regional banks that have adequate liquidity reserves, but are not highly exposed to commercial real estate. The major regional banks have been analyzed for liquidity, which gives us a high degree of confidence that they are capable of meeting even the most stringent liquidity scenarios. There are many trust banks in the United States, but Northern Trust NTRS +0.49% [ticker: NTRS] is the largest and most important. It is likely that PNC Financial Services Group [PNC] and US Bancorp [USB] will gain deposits flowing out of smaller banks in order to become high quality “super” regionals.

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It was our team’s goal to find the best opportunities within the financial sector that didn’t require the liquidity concerns of the banks, such as asset management, insurance, and insurance brokers, in order to reduce the risk of liquidity. There are many examples of companies such as Ameriprise AMP +0.58% [AMP] that provide quality asset management services and retail brokerage services that are not at risk of deposit flight, and Brown & Brown that provide insurance services without incurring balance sheet risks.

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There should, however, be a great deal of caution when it comes to confidence events, as when it comes to the credit crisis, confidence can turn quickly.

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The most important question for investors right now is where should they park their cash?

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A lot of businesses and individuals need cash in the short term for unforeseen emergencies and daily needs, such as cash in the next four to six months. That is why we advise our investors to divide their cash needs based on time. If you have a short-term time frame of a few months, you might want to consider investing in a money-market fund rather than a bank.

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Among the reasons why we are seeing such significant money-fund flows is the fact that these are presumably the result of bank deposits, particularly those from smaller banks. It is likely that we will see continued moves in this direction if pressures within the banking system continue to mount and spread. As a result of its liquidity and short-term nature, government money funds have yields around 4.7% gross and 4.5% net. I would recommend owning government money funds for these reasons.

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There was trouble in the money markets in 2008-09, so should investors be cautious now that things seem to be improving?

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Money markets are always prone to crises of confidence, as they act as the heart of the financial system. However, the functioning of the money market appears to be under control at the moment. There seems to be adequate liquidity flowing into the financial system, through banks' term facilities programs.

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We will certainly have to pay close attention to how liquidity plays out here in terms of how things will play out, as it will certainly play a significant role in determining how things turn out. Over the past two weeks, over $200 billion in assets have flowed into institutional government money funds. This asset class is now worth over $5.5 trillion, which is an all-time high.

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What are good ways to earn money that you will not need in the next year or two but that you can share with others?

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With the market volatility over the past year, yields have skyrocketed and curves have flattened out, resulting in an inverted curve that provides a compelling case for short-maturity bonds. In the short term, investors will still be able to generate attractive yields and decent protection to withstand further volatility if they choose ultrashort or short-term bond strategies with a one- to two-year horizon.

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A relatively safe investment can be found by assuming you can withstand some degree of principal volatility, that you do not need immediate liquidity and have some flexibility to wait out this rout if you have some ability to handle limited principal volatility. In the past, these strategies had a good history of positive returns. During the past 20 years, there have been two calendar years where the Bloomberg 1–3 Year U.S. Government/Credit Index has experienced negative returns.

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In light of this latest quarter-point increase in interest rates, where do you see the Federal Reserve taking them next?

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In February, we saw a significant improvement in employment and growth, prior to the Silicon Valley Bank failure. Thus, it seems likely that the Fed will continue to focus on moderating persistent inflation, and we might see one more hike in May before a pause in policy. There was, however, an acknowledgement that there is still a tension between meeting the inflation objective credibly and maintaining a stable financial system. I believe 5.00% to 5.25% would be a reasonable range for where rates peak based on the reaction in the market and the Fed even more clearly indicating they are close to a pause.

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What are your expectations for the Fed's inflation target of 2%? Is it likely to be met?

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There is an opportunity that inflation is going to settle in at a slightly higher level than what has been arbitrarily set as a target over the course of time, which is quite likely to be the case. While the Fed may not be able to say that, I believe we might have to adjust to it and settle into a higher rate. Inflation is an era of returns, so you must take that into account. In spite of that, we still have a lot of room at these levels for short-term bonds to make some attractive returns at these levels, as long as inflation settles at something lower than what it is now, perhaps around 2%.

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During your career, you have had a lot of experience with junk bonds. What is one of the lessons you have learned from those experiences?

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During that period, I had some conversations with people and observed certain things that were out of place, which taught me to question the things that don't seem right.

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Are there any things that don't seem to be right right now?

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There is a tension between the economic situation and the many strengths we have—in companies and banks—and the market's reaction. The question is, does this still constitute a crisis or is it just a moment? It is important to remember that the market can certainly react in a way that can certainly lead to a near-term evolution of outcomes. I think we will continue to wait to see if this is a momentary crisis or a momentary one.

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It would be more accurate to say that right now we are in a fractured moment. There are fissures growing that aren’t 100% certain will lead to a full rupture, but it is not our perception that they should, and so we are looking for opportunities that can help us.

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What is the point at which something fundamental breaks down as opposed to thinking it is a moment but was a crisis all along?

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Seeing that we are not seeing more bank failures is a good sign for me. If more do occur, then we will feel more concerned, and that is when you turn a waning-confidence issue into a full crisis. The regulatory programs have improved over the years, but they also take some time to work. In order for the programs to work, the market must be patient. If the market loses patience, that could change the trajectory of the industry.