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Are money market rates poised for a comeback?

April 05, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Is your money market account stuck in a rut?

If so, you're not alone. Money market rates have been locked into a long and steady descent for a few years now, resulting in average money market rates of just 0.14 percent as of the end of March. Finally, though, there are signs that this could change in the months ahead.

Treasury bond yields trended upward in March, in reaction to a streak of positive economic news. This could ultimately start to affect money market rates, but there are still some obstacles to overcome.

Higher treasury bond yields

After spending most of January and February below 2.00 percent, 10-year Treasury bond yields broke through on the upside in March, reaching a high above 2.30 percent before falling back a little. As this is written, they are still holding onto ground in a range around 2.20 percent. If they don't slip back again, this would represent the first sustained upward progress for bond yields since late 2010.

This is largely in reaction to positive economic news on the domestic front -- in particular, a string of encouraging employment reports. Adding jobs has the potential to generate continuing economic momentum, which would eventually create an environment that could support higher interest rates.

The impact of inflation

Unfortunately, the rise in bond yields may not be entirely due to positive economic developments. The most recent Consumer Price Index report showed a 0.4 percent increase in February, which if continued would project to an inflation rate of nearly 5 percent a year.

So far, this is a one-time uptick in inflation, and the rate for the last 12 months remains a moderate 2.9 percent. However, the high inflation reading for February is troubling in the context of rising oil prices, which have a way of spreading inflation to other segments of the economy. Higher inflation could push interest rates higher without really helping money market accounts.

The Fed, and other obstacles to higher rates

Besides inflation, there are a few other obstacles for money market accounts. Specifically, here are three things that could derail money market accounts on the way to higher interest rates:

  1. Federal Reserve policy. The Federal Reserve has somewhat painted itself into a corner with a multi-year commitment to low interest rates. Money market rates can rise without the Fed, but it will be more difficult.
  2. A European recession. For some countries in Europe, the question isn't whether they will go into recession, but how deep it will be. The resulting reduction in global demand will hold interest rates back.
  3. Slower growth in China. When it comes to China, the issue isn't one of recession, but simply of a more moderate rate of growth. However, the effect is the same as with the prospect of recession in Europe -- an incremental drop in world demand growth.

When balanced against signs of job growth in the U.S., it is difficult to tell from day-to-day which of these factors might be gaining the upper hand. However, bond market yields provide a continuous assessment of economic developments, and based on recent moves, those yields seem ready to break out of their low-rate rut. The next question is, how soon will money market accounts follow?

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