MoneyRates Blog

The U.S. stock market posted its fourth consecutive weekly decline last week, and the volatility of stocks seems to be accelerating. Take your pick of possible causes: continued foreclosures, a weak job market, sovereign debt worries, or simple overvaluation. Most likely, all of the above and more have played a hand in the stock market’s woes.

All things considered, you’d think this would be a good time to be in deposit accounts. That’s not really the case, though. Certainly, it beats the negative returns that stocks have suffered lately, but bank account owners aren’t exactly celebrating. With savings account rates, money market rates, and CD rates already pitifully low, depositors have to be concerned about signs that this latest round of trouble with stocks will bring more downward pressure on bank rates.

Along with the drop in stocks over the last four weeks, interest rates have fallen across almost the entire yield curve since a month ago. Bonds are viewed as a “safe harbor” in times of stock market volatility. As investors flee from stocks into bonds, the demand for bonds drives interest rates down. Ultimately, this can have a spillover effect on bank rates.

Longer term, recent concerns about the economy could make the Federal Reserve and other policy makers remain slow to back off the various measures they’ve taken to keep interest rates down to stimulate the economy. It’s another reason that even though deposit accounts have been safe amid recent stock market turmoil, they haven’t been winners in this environment.

When speaking of the banking system and bank rates, we often forget that this system is comprised not only of buildings, computers, and money, but of people. One vivid illustration of this fact is to ponder the role that American senior citizens may increasingly play in the interest rates paid for CDs, money market accounts, and savings accounts.

First of all, there are going to be many more people who fit the category senior in the coming years. As this article about the aging of America shows, statistics indicate that by the year 2020 there will be 115 million senior citizens in the U.S.

But it is not only about numbers, it is also about mentality. This new class of seniors, at the risk of putting it bluntly, has some conflicting attitudes about money. On the one hand, Baby Boomers have acquired wealth unlike any other generation in American history. At the same time, the fear of running out of money in old age is palpable.

Obviously each individual person will make varying choices, but as a whole, are there certain saving trends among this group that will affect interest rates on CDs, money market accounts, and savings accounts?

For example, if banks do keep rates low, will seniors seek other options for making money with their money, or will the safety of an FDIC-insured deposit account rule the day?

As of now, there are more questions than answers on this front, but certainly this demographic shift will have far-reaching consquences for many aspects of the banking system.

The yield curve, which is a line plotting the yields of income securities from short-term to long-term, is steeper than it has been since the 1990s. Unfortunately, most bank rates are on the wrong end of that curve, and this represents yet another way that depositors are paying for the recovery of the banking sector.

Short-term U.S. Treasuries are still yielding close to nothing, while 30-year Treasuries are up over 4.5%. The spread between the two is what makes the yield curve steep. Unfortunately, savings account rates and money market rates are based primarily on the short-term end of the yield curve — the part that is barely above zero. CD rates are more of a mixed bag, depending on the length of the CD, but for the most part CD rates would fall along the lower end of the yield curve as well.

This has been a bonanza for the banking industry. They can pay depositors virtually nothing for capital, and then invest that capital at significantly higher rates in the bond market. With the yield curve steep, banks can make a nice profit on deposited assets without taking the risk of lending them out. However, banking regulators issued a warning last month that this profit model is sensitive to a rise in short-term rates.

What the regulators realize is that the short-end of the yield curve is strongly influenced by Federal Reserve policies, while the long end is set by a freely-traded market. The short-end has been kept artificially low to help stimulate the economy — and to bail out the banks. This artificially steep yield curve can’t be sustained forever, but in the meantime, depositors at the short end of the yield curve are getting the short end of the stick.

Once you start to acquire money, people who manage money tend to start appearing. Financial advisors who can guide you in the ways of stocks, bonds, and maybe even real estate.

Once you’re savvy to those options, having money in a savings account can come to seem rather boring. Finding a high interest savings account online may provide a temporary rush, but to the investor with an agitated mind, the yield on a savings account will not exactly set your heart racing.

However, there is no excuse for going without a healthy savings account if at all possible.

Possessing a healthy savings account can help you deal with:

– Job loss

– Medical bills

– Car repair

In other words, the unexpected things of life that inevitably occur.

With the savings rate in America on the rise, it appears that more people are remembering the importance of funding your savings account. And remember is the right word for it, because anyone who learned anything about money as a child can remember the mystique of opening your first savings account.

As this bank study indicates, the goal of a savings account for every American is not yet even close to reality. In fact, 17 million Americans have no bank account at all.

Frustrated with low bank rates? Understandable, but as you think about alternatives, take a careful look at recent signs that the stock market might be in for another dive. If so, it could make those meager bank rates look like a real bargain.

Last year saw a tremendous recovery for the stock market, after the steep declines of 2008. Sometimes, though, stock markets overreact on both the downside and the upside, and it is entirely possible that stocks got a little ahead of themselves by the end of 2009. Certainly, market participants have been showing signs of buyer’s remorse of late.

The reason for concern is not in the recent economic news itself, but in the stock market’s reaction to that news. For example, last week it was announced that the U.S. Gross Domestic Product grew at an annual rate of 5.7% in the fourth quarter of 2009, at least according to the first estimate of economic growth. This was a much stronger showing than most economists had expected.

Similarly, individual company earnings have been stronger that expected, for the most part. Some 73% of the companies which have released fourth quarter 2009 earnings reports so far have beaten formal analyst estimates.

So how has the stock market responded to these encouraging fundamentals? By losing 3.7%, much of it just last week.

When the stock market reacts negatively even in the face of good news, it can be a sign that expectations — which translate to prices — had been built up too high. When this happens, it often means a downward correction in stock prices is necessary.

If that’s the case, savings account rates, money market rates, and CD rates might not seem quite so bad over the next few months.