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  • Writer's pictureJoe Kennerson

The Deposit Lag

Deposits360°® Monthly Industry Review
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The market has spoken, and the Fed has signaled a pivot. At least for now. The recent bond market rally and expected 2024 Fed cuts mean that the peak in deposit competition for this cycle is likely behind us. Now the question is, what lies ahead on the other side? The yield curve remains inverted and margin pressure is not going away in the short run. In fact, deposit rates lag on the way down just as they do on the way up.

So the search goes on for the optimal deposit strategy to fund loan growth and manage funding costs. While the equilibrium may be difficult to find, we know that every basis point counts. And there are certainly basis points up for grabs given the impending Fed pivot.

I was fortunate to present on this subject at the Bank Director Acquire or Be Acquired conference in Phoenix recently where I focused on the deposit outlook ahead of an easing cycle. The following are the highlights from the AOBA session.

Still Catching Up

We are not quite out of the woods yet with deposit cost and mix changes as the industry continues to feel the aftershock from Fed tightening. According to DCG’s Deposits360°® non-maturity deposit forecast (running on real-time data from nearly 300 institutions), a “higher for longer” scenario, which keeps Fed Funds rates flat, projects non-maturity deposit rates to rise 11 bps over the next year (starting 12/31/23).

DCG’s “futures” forecast, which builds in the Fed Funds futures as of mid-January, projects non-maturity deposit costs to fall 10 bps over the next year. However, that cost reduction is very much back-end weighted, which is a critical theme in advance of a Fed pivot and potential relief on deposit pressure.

Lagging on the Way Down

We lag just on the way down just like on the way up. The concept is simple. Liquidity levels are generally still tight early in the Fed cycle, and, quite frankly, the industry fought hard for the deposits during the cycle that most are not rushing to cut rates.

This lag is noticeable in our data. The chart below projects non-maturity deposit costs under four falling rate scenarios as of 12/31/2023. Non-maturity deposit rates are still sticky in the early stages in even the more aggressive falling rate scenarios.

Interest Rate Summary

Three Strategies to Consider

The ability to beat this lag will be critical for two reasons. First, margin pressure is painful for many. Second, loan pricing pressure is likely to continue given that 5-year market rates are 70 basis points off their autumn highs.

Here are three potential strategies to raise at your next ALCO meeting.

  1. Build a Fed Easing Playbook: If the Fed cuts 50 bps at the May meeting, what’s your plan? Down 100bps by fall, how do you react? Start role-playing this at ALCO. Stratify the depositor base by exception pricing tiers and segment legacy products vs new specials. Build the playbook now to avoid being reactive.

  2. Develop a Comeback Campaign: This concept seems convenient but is tough to execute. I recently pulled a list in Deposits360° for a client that showed their top 20 biggest MMDA outflows during this cycle for depositors who are still banking with them. There will be an opportunity to make a play on winning back those deposits during the easing cycle.

  3. Take an ALCO Approach to Deposit Pricing: One of the most challenging decisions many bankers will face this year is balancing deposit retention vs lowering cost of funds. Take a full balance sheet management approach when pricing deposits, not just comparisons to local market competition. For example, how aggressive should pricing be on retaining hot money deposits today when wholesale funding levels are 4.50% for two-year terms? Understanding the cost of foregoing a rate cut to help manage margin will be a difficult, but a critical concept for 2024.

Deposit costs are likely to move higher before going down. Expect deposit rates to lag in the early stages of the Fed cycle. Preparing for that today with your risk modeling, forecasting, and more importantly, building out your Fed Easing Playbook, will help beat the lag during the next cycle.

Contact us to learn more about developing your optimal deposit strategy for funding loan growth and managing funding costs.


Joe Kennerson is a Managing Director at Darling Consulting Group, developing custom balance sheet strategies with ALCOs throughout the country. DCG’s Deposits360° solution captures relationship-level data for financial institutions with a goal to track cannibalization, quantify the marginal cost of funds on deposit specials, forecast volume and rate expectations, and most importantly, develop effective deposit pricing and product strategies.


© 2024 Darling Consulting Group, Inc.


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