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A Greek comedy threatens money market rates

November 14, 2011

| MoneyRates.com Senior Financial Analyst, CFA

Short-term Treasury yields are good indicators for the direction of bank rates in general, but they are especially significant in connection with money market accounts. In recent weeks, Treasury yields had been pointing towards higher rates--until they got caught up in the turmoil over Greek debt.

The Greek crisis sent Treasury yields tumbling, effectively wiping out signs of optimism for money market rates.

Making the connection: Treasury yields and money market accounts

Think of bank rates as interest rates with a shock absorber. They won't bounce up and down as much as freely traded rates such as Treasury yields, but they will follow the long-term direction of those yields.

The relationship between bond yields and bank rates is especially valid for money market accounts. Conceptually, money market accounts are designed to earn yields for depositors by investing in short-term, fixed-income securities. The more those securities yield, the more money market accounts can pay. Thus the general trend in short-to-intermediate Treasury yields, such as the rate on a three-year bond, can be a good indicator of the direction money market rates are likely to take.

In late September and most of October, three-year Treasury yields had been heading upward. Then a bizarre twist in the Greek financial crisis wiped out all this progress in a matter of days.

The Greek setback

Greece is in danger of defaulting on its sovereign debt. Long, painstaking negotiations with European Union countries had sought to work out an orderly settlement of that debt. The idea was to find a compromise that would balance the losses by the holders of that debt, the financial support required by the European Union, and the sacrifices by Greece in the form of fiscal austerity.

In the final days of October and the first days of November, developments in this situation came fast and furious:

  • An agreement between the European Union and Greece was announced.
  • Greek Prime Minister George Papandreou unexpectedly announced that he would submit the deal to a national referendum. Complicated matters of national finance don't really lend themselves to popular votes, especially when the outcome involves austerity measures. This move gravely endangered the settlement.
  • Papandreou then reversed his call for a referendum, but by this time he had lost so much credibility that his government was in danger.

Even though Papandreou reversed course, he could not reverse the new uncertainty he had brought to what was already a very tricky settlement deal. If there is one thing the financial markets hate, it's uncertainty.

Follow the bouncing yields

Bond yields tend to rise on signs of economic optimism and fall on signs of pessimism. From September 19 to October 27, three-year Treasury yields rode a growing mood of optimism up from 0.29 percent to 0.53 percent. Then, as the Greek deal fell apart, they fell back to 0.37 percent in just four trading days.

In short, what was starting to look like an optimistic signal for money market rates instead now resembles, appropriately enough, the Greek myth of Sisyphus, who was doomed for eternity to roll a heavy boulder up a hill--only to see it roll back down again and again.

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