Look out below! What bond yields mean to money market rates
September 02, 2011
For all the doomsday predictions about what the budget crisis, credit downgrade, and U.S. government deficit would mean for Treasury bonds, investors have been flocking into Treasuries for the past several months. That sounds like good news--unless you are trying to earn a decent rate of interest on your money.
When a bond price goes up, the yield on that bond goes down. Effectively, yields are interest rates that shift constantly according to changes in the marketplace. And with people buying Treasury bonds as if they were iPhones lately, yields have been plummeting. This makes it important to understand what this will mean for money market rates in the months ahead, and more precisely, how to read the relationship between Treasury bonds and money market accounts.
A tale of two interest rates
Both Treasury bond yields and money market rates are influenced by general trends in interest rates, but since Treasury bonds are traded daily while money market rates are set by banking decisions, Treasury yields tend to be more immediately sensitive to economic changes. This makes them an interesting indicator to watch for clues as to the future direction of money market rates.
Since Treasury bonds represent a range of different rates, depending on the length of the security, the next thing to figure out is which Treasury bonds are the best indicator of money market rates.
Which Treasury bond rates influence money market rates?
Broadly speaking, short-term Treasuries can be expected to have more in common with money market rates than long-term Treasuries, but deciding which short-term Treasuries match up best with money market rates can be a tricky thing. As of late August, you could get the impression that two-year Treasuries were the best match for money market rates, since those bonds were yielding 0.20 percent while average money market rates, according to the FDIC, were 0.19 percent. However, that relationship has changed radically over the course of this year, and that change might say something about the future of money market rates.
Over the past couple of years, money market rates have usually been somewhere in between the yields of six-month and one-year Treasuries. Meanwhile, two-year Treasury yields have been significantly higher. For example, at the end of 2010, money market rates were at 0.23 percent, which at the time fell between the 0.20 percent yield on six-month and 0.30 percent yield on one-year Treasuries. At that point, two-year Treasuries were still at 0.67 percent.
Since then, while money market yields have fallen only slightly, to 0.19 percent, Treasury yields have dropped sharply. One-year Treasuries now yield 0.11 percent, and six-month Treasuries just 0.06 percent. Two-year Treasuries have fallen the farthest, from 0.67 percent to 0.20 percent.
The fact that money market rates now more closely resemble two-year Treasury yields, rather than yields on shorter-term Treasuries, could suggest a couple of things. One is that money market rates have farther to fall, following short-term Treasury rates down. The other is that with longer-term Treasuries now moving closer to the low level of money market rates, the marketplace is expecting low rates to be here for a long time. Neither of these messages from the bond market is cheery news for money market accounts.
