As banking turmoil roils markets, Cheryl Mickel, who oversees money markets, short-term taxable bonds, and stable value for
T. Rowe Price
fixed-income group, is finding opportunities amid the chaos—even in the short-term debt of banks.
Whether the recent troubles among U.S. regional banks and some European giants will become a widespread crisis has yet to be determined, says Mickel, who heads T. Rowe Price’s U.S. Taxable Low Duration Group, overseeing more than $100 billion in assets. But rather than hunker down, Mickel’s team is searching for opportunities to lock in higher yields.
In recent weeks, two-year bonds have logged their biggest price swings in decades. That volatility creates opportunity in a market that took a beating in 2022, leaving cash and short-term bonds generating attractive yields for the first time in a decade.
We talked with Mickel, one of Barron’s 100 Most Influential Women in U.S. Finance, ahead of the Federal Reserve’s 25-basis-point hike, and again on March 24 via email, to find out the best spots to park cash for a year or two, how to navigate the banking sector, and where the Fed may be going next. An edited version of our discussion follows.
Barron’s: What stood out in the comments coming from the Federal Reserve after its recent quarter-percentage-point interest-rate hike?
Cheryl Mickel: [Fed Chairman Jerome] Powell’s directness in stating they will raise interest rates again, if needed, and acknowledgment that the banking crisis’ impact is still uncertain. The Fed was very transparent about the concerns around the banking system. Central banks are making every effort to bolster confidence, but this is a narrative that they may not be able to effectively convey—and one that markets aren’t yet embracing. We are seeing elevated flows away from deposits, causing funding pressure for smaller banks, and concerning points of stress in the market around other large banks, such as
The wild card is how much the banking crisis restricts credit growth.
Are we in a full-blown crisis?
What we are facing right now is more of a test of market confidence. You are seeing a market that doesn’t want to believe that there is still some resilience to the economy and to the banking sector.
There are some things different in this particular “crisis” than past crises in everybody’s memories. The economy is much stronger than it was during the [2008-09] global financial crisis. And there has been so much regulation to build resilience that, in aggregate, banks are in much stronger position. Also, government support is earlier, practiced, better targeted, and not dealing with the capitalization issues of the past.
That is the rational viewpoint, but all the assurances of resilience in banking systems around the globe don’t yet seem to be taking hold, leaving more time for fissures to form and cracks to become breakage.
How does that affect what you want to own?
The move we are seeing in the market can wreak unforeseen havoc from hedges and positioning that may be off sides, so you have to be on high alert here. We have been conservatively positioned and are starting in a ZIP Code of higher rates, which provide a lot of cushion that we didn’t have a year ago.
What areas are you worried about?
Smaller banks are experiencing increasing funding pressures, so we would suggest caution there. A lot of midsize banks are in commercial real estate, so we’d use caution in those areas.
We are looking for dislocated pockets of opportunity. All yield is not created equal, so we are looking selectively for strong credits that can weather the volatility. We look through each company and put each in context within the broader market, searching for strong business models and cash flows. We are looking at the ability [of banks] to withstand a run, what their asset base looks like—and how they are managing it—and differentiating among specific companies based on how they are positioned to withstand volatility.
What are examples of attractive opportunities?
It’s important to not hunker down and just assume all the regionals are a bad place to be. It’s just not true. There’s some trust banks and quality regionals that have ample liquidity reserves and aren’t highly exposed to commercial real estate. We have done liquidity analysis on the major regional banks that gives us confidence they can meet even a stressed-liquidity scenario. For example,
[ticker: NTRS] is a high-quality trust bank focused on institutional deposits.
PNC Financial Services Group
[USB] are high quality “super” regionals likely gaining deposits flowing out from smaller banks.
The team has been finding some of the best opportunities in financials that don’t have the liquidity concerns of the banks, such as asset management, insurance, and insurance brokers. For example,
[AMP] is a high-quality asset management and retail brokerage business that’s not subject to deposit flight, and Brown & Brown is an insurance broker with no balance sheet risk.
But proceed with caution, because when it’s a confidence event, confidence can turn quickly, as we saw with Credit Suisse.
Where should investors be parking their cash right now?
We advise our investors to divide their cash needs by time. For example, businesses and individuals usually have cash required in the very short term for unforeseen emergencies and daily needs—think zero-to-six months. This might be in a bank, or you may consider a money-market fund with a time frame of a few months.
We are seeing money-fund flows growing significantly, and this is presumably out of bank deposits, especially from smaller banks. If pressures within the banking system continue to mount and spread, we’ll see continued moves in this direction. I would consider owning government money funds for liquidity and short time frames. Yields for government money funds are in the 4.7% range, gross; 4.5%, net range.
Money markets ran into trouble in 2008-09. Should investors be cautious now?
A crisis of confidence can always show itself in money markets; they are the heart of the financial system. So far, the functioning of the money markets seems to be under control. Banks are tapping adequate and reported precautionary liquidity through bank term facility programs.
How liquidity evolves here will certainly be important in terms of how things shape up, and we will have to continue to watch it. Assets continue to flow into institutional government money funds—about $200 billion over the past two weeks. The asset class is at an all-time high, at over $5.5 trillion.
What are good opportunities for money that’s not needed for a year or two?
The market volatility of the past year has led to higher yields and flatter, now-inverted curves, which creates a compelling case for short-maturity securities. Investors with a one- to two-year horizon can think about ultrashort or short-term bond strategies and still get attractive yields with decent protection to withstand further volatility.
They can be relatively safe if you have some ability to withstand limited principal volatility and don’t need immediate liquidity and can be somewhat flexible to wait out this rout. These strategies historically have a long history of positive returns. The Bloomberg 1–3 Year U.S. Government/Credit Index had two calendar years of negative returns over the past 20 years through December 2022.
Where do you see the Fed taking interest rates after this latest quarter-point increase?
It’s most credible for them to remain focused on moderating persistent inflation, and we saw upside in employment and growth in February, prior to the Silicon Valley Bank failure, which could lead to one more hike in May before a pause. But there was clear acknowledgment that challenging tensions remain between credibly meeting the inflation objective and tenuous financial stability. Given the market reaction and the Fed even more clearly confirming they are likely nearing a pause; 5.00% to 5.25% seems a reasonable range for where rates peak.
Do you expect the Fed to hit its 2% inflation target?
There’s a real possibility that inflation may need to settle in at a slightly higher level than what has been arbitrarily set as a target over time. I don’t think the Fed can say that, but I think we may have to live with it settling in at a higher rate and the economy just adjusting. Inflation is an eroder of returns, so you have to consider that. But with inflation settling into something lower than what it is now and toward 2%, that still leaves a lot of room at these levels to get some attractive returns in short-term bonds.
You experienced the junk-bond meltdown early in your career. What was one of the lessons from that crisis?
Some of those conversations and my observations [during that period] taught me to question what doesn’t seem right.
What doesn’t seem right at the moment?
It’s the tension between where the economy sits and the many points of strength—in companies and banks—versus the market’s reaction. But you can’t discount the market’s reaction because that can certainly lead to a near-term evolution of outcomes. The question: Is this still a crisis or just a moment? I think we are still waiting to see that evolve.
Right now, let’s say it’s a fractured moment. There are fissures growing that we aren’t 100% sure will lead to a full break. But it doesn’t feel like it should—and because of that, we are looking for opportunities.
When do you shift from thinking it may be a moment to a crisis, with something fundamentally broken?
If we aren’t seeing a series of continued bank failures, I think that’s a good sign. If we were to see more, that would bring more concern, and that’s when you turn a waning-confidence issue into a full crisis. We have seen regulatory programs get better and more effective. But they have to have time to work, so the market has to have some patience. If the market loses patience, that could change the trajectory.
Write to Reshma Kapadia at firstname.lastname@example.org