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Personal Finance Blog By MoneyRates

Market volatility threatens mortgage and deposit rates

October 17, 2014

| MoneyRates.com Senior Financial Analyst, CFA

In the first 12 trading days of October, the Dow Jones Industrial Average suffered six daily losses of 100 points or more. Given that the month started off with encouraging economic news, what could be plaguing the market?

It seems the market has slipped into a worst-of-both-worlds mentality. That could make stocks a volatile place to be, and could eventually impact consumer interest rates.

The worst-of-both-worlds outlook

Toward the end of September, the Bureau of Economic Analysis released an upward revision to their estimate of second-quarter GDP growth, pushing it to 4.6 percent. A week later, the Bureau of Labor Statistics released an report showing strong employment growth -- 248,000 new jobs -- in September. With such a positive lead-in to October, why has it been such an ugly month for the stock market?

There are a couple of factors at work. For one thing, the market has long been wary that signs of growth will bring higher interest rates, something that can have a suppressive effect on both economic growth and stock valuations. Meanwhile, the other factor is that a variety of developments have recently cast doubt over global economic growth rates.

As a result, the market seems to be suffering from a worst-of-both-worlds outlook, viewing the economy as just strong enough for interest rates to rise, but not strong enough to withstand a global slowdown.

Impact on bank rates

The worst-of-both-worlds scenario could result in the widening of two interest rate spreads that impact consumers:

  1. The spread between mortgage and savings account rates. Current mortgage rates may seem low, but according to the MoneyRates.com CLIP Index, they are actually unusually high compared to rates on savings accounts. This could actually get worse, as the Fed has already largely discontinued its active program to keep long-term rates low, but may keep short-term rates down a little longer if global growth concerns become pervasive.
  2. The spread between rates for bad and good credit customers. A slow economy often means lower interest rates, but it also raises credit concerns. So, people with shaky credit histories may actually see rates on things like credit cards and mortgages rise, while general market rates hold steady or decline. The message is, this is a very important time to keep your credit history in good shape.

After the Fed held interest rates at unnaturally low levels for such a long time, letting those rates rise always had the potential to be disruptive. Now, a variety of factors on the global scene threatens to further shake up the interest rate picture.

The message for consumers is to lock in borrowing rates, and be alert for changes in savings rates. At just over 4 percent, current mortgage rates are still historically low, meaning that people in the market should act soon to secure their mortgages, and favor fixed over adjustable-rate loans.

People with savings accounts, meanwhile, should closely watch both their own rate and the market for rates in general. A volatile environment tends to create both opportunities and risks.

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Report reveals unfavorable banking trends for consumers

October 4, 2014

| MoneyRates.com Senior Financial Analyst, CFA

The FDIC recently updated its annual Summary of Deposits, which tallies the number of banks and branches in the U.S., along with the amount of money they have on deposit. These figures, along with the FDIC's running total of bank closures, reveals some noteworthy -- and contradictory -- trends for bank customers.

The good news is that the banking industry continues to become more stable. The bad news is that consumers may be paying a price for that stability, in more ways than one.

Changes in banking

Here are some of the key trends indicated by the FDIC data:

  1. Failures continue to slow. Considering that it is still just a few short years after of the financial crisis, when the banking system seemed on the verge of collapse, perhaps the most important trend in banking is that the system continues to stabilize. Just 12 banks failed in the first half of 2014, 25 percent fewer than went under in the first half of 2013.
  2. Despite fewer failures, banks are disappearing. While fewer banks have been failing, the total number of banks is declining at a rapid rate. As of June 30, 2014, there were 281 fewer banks than there had been a year earlier. Even though there were not many failures, these numbers reflect a continuing trend of mergers and acquisitions in the industry. This consolidation is a response to the new, tougher financial environment for banks, which means that customers can likely look forward to further rising fees on their checking accounts.
  3. Branches are becoming more scarce. The total number of bank branches declined by 1,614 in the space of a year. This also reflects the industry's challenging financial realities, meaning that in addition to higher costs, customers can also look forward to less service in some areas.
  4. Deposits continue to grow. Even with reductions in the number of banks and branches over the past year, deposits increased by a net total of $679 billion. Despite low interest rates, rising fees and service reductions, banks are having no trouble attracting deposits. That is bad news for depositors with savings accounts -- with money continuing to flood in the door, banks have little incentive to raise interest rates to attract deposits.
  5. It is still a highly fragmented industry. The number of banks may be on the decline, but there are still more than 6,500 banks in the U.S. In addition, the proliferation of online accounts has broken down geographic barriers to make more options available in some areas. So, as a way of coping with rising fees and falling savings account rates, remember that there are many choices out there. Consumers who shop around can neutralize some of the negative trends in banking.

Ultimately, stability is what matters most to bank depositors, and the U.S. banking system continues to demonstrate its ability to deliver that precious attribute. Unfortunately, between low interest rates, rising fees and dwindling service, that system is providing little more than security to customers today.

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Savers benefit from rare inflation break

September 22, 2014

| MoneyRates.com Senior Financial Analyst, CFA

With average rates on savings accounts near zero, bank depositors have been long been waiting for some sort of relief. They got it from an unlikely source last week -- the report on inflation for August.

News that consumer prices actually declined in August was a sort of instant win for savers. The big question now is whether that win will prove to be short-lived.

An bright moment for savers

The Bureau of Labor Statistics reported that the Consumer Price Index (CPI) declined by 0.2 percent during August. Seasonally adjusted, this is the first decline in the CPI since April of last year, and is tied for the largest decline since December 2008.

A drop of 0.2 percent may not sound like much, but if continued over a full year it would project to a decline in prices of more than 2 percent. Any decline in prices increases the purchasing power of savings, which is how this decline in CPI represents an instant win for savings accounts.

The ideal situation for savings accounts would be for economic activity to pick up to the point where interest rates started to rise. That, however, is likely to be a long and halting process. In the meantime, the average savings account rate is stuck at 0.06 percent, meaning that in order for savings accounts to gain purchasing power, inflation virtually has to turn negative. This does not happen often, but it happened in August.

Instant, but temporary?

At this point, the question becomes one of how much lasting value this gain in purchasing power will prove to have. That instant win for savings accounts may prove to be temporary.

For one thing, inflation figures tend to be pretty erratic from month to month. This is especially true in the energy sector, and it was a decline in energy prices that was the primary reason the CPI declined in August. A drop in energy prices one month is often followed by a bounce back the next month, so the recent decline should not be looked at as a trend that is likely to continue.

The other issue is that any decline in consumer prices raises doubts about the strength of the economy. One month of falling prices does not put the economy on a long-term deflationary path, but it was enough to drag the year-over-year inflation number down to 1.7 percent. This is below the 2.0 percent level the Federal Reserve considers healthy. So, August's decline in prices might hurt interest rates in the long run by delaying the return of monetary policy to more normal rates.

Taking all this into consideration, today's inflation news represents the dilemma for interest rates right now. Too much inflation erodes purchasing power, and too little could delay the return of rates to normal levels. The temporary win savings accounts got from the drop in CPI will only have lasting value if it is followed by stronger economic growth.

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Interest rates languish despite encouraging economic data

September 4, 2014

| MoneyRates.com Senior Financial Analyst, CFA

The last week of August saw confirmation that economic growth is back on track, yet interest rates hardly moved in response. It may not be so much that investors are ignoring economic developments as they are simply skeptical about them.

Stronger growth is still the tonic most likely to cure low interest rates, but it is increasingly evident that bigger doses of this tonic may be required.

Growth gets back on track

On August 28, the Bureau of Economic Analysis announced that it was revising its estimate of second quarter, 2014 growth upward by 0.2 percent, to a 4.2 percent real annual rate. This reinforced the impression that economic growth has gotten firmly back on track after stumbling badly in the first quarter.

In fact, not only is a 4.2 percent growth rate very good in its own right, but the upward revision of the earlier estimate created a positive contrast with the way data for the first quarter evolved. The official estimate of first quarter GDP growth was revised downward twice, finally settling at an annual rate of -2.1. In other words, reports on the first quarter were a case of bad news getting worse. So far, assessment of the second quarter's growth looks like a case of good news getting better.

Negative real rates

Another factor in the interest rate mix is inflation. Ordinarily, people do not want to invest or lend money without a reasonable expectation of getting back more purchasing power than they pay out. This is why interest rates historically have exceeded the inflation rate, but the past few years have been an anomaly in this respect.

For example, over the past year inflation is running at a 2.0 percent rate. That's actually a fairly moderate inflation rate by historical standards, but its is more than enough to beat the interest rates on savings accounts, money market accounts and most CDs, and even enough to exceed the yield on Treasury securities of five years or less.

An abundance of caution

Why are interest rates staying so stubbornly low? It seems as though investors are acting with an abundance of caution.

A 4.2 percent growth rate is all well and good, but the economy has still yet to show that it can string together consecutive quarters of such growth, rather than just showing occasional flashes followed by disappointment. The economy has not strung together consecutive quarters with real growth rates in excess of 4 percent since 2003. Only when the economy can sustain that kind of growth for three or four quarters at a stretch will the confidence of consumers, lenders and investors be restored enough to boost interest rates.

In the meantime, people turn to vehicles like savings accounts out of just the sort of caution that characterizes the current environment. The irony is that with interest rates trailing the rate of inflation, the reward for that caution has been a steady loss of purchasing power.

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Savers, borrowers get a break from weakening inflation

August 22, 2014

| MoneyRates.com Senior Financial Analyst, CFA

Inflation eased in July, thanks to help from an unexpected source -- energy prices -- which had been a prime mover in a surge of inflation over the prior three months.

On August 19, the Bureau of Labor Statistics (BLS) announced that the Consumer Price Index (CPI) rose by just 0.1 percent in July. That moderate rate of inflation comes on the heels of accelerating price increases in the second quarter of the year, and this easing is good news for consumers fighting rising prices, for mortgage shoppers hoping to still take advantage of low mortgage rates and for beleaguered depositors in savings accounts.

The only question is, can this respite from faster-rising prices last?

Inflation slows in July

Prior to the most recent CPI report, inflation had been on a troubling course. After spending much of the past few years at around 2 percent or lower, CPI rose at an annualized pace of 3.5 percent in the second quarter of this year. This higher rate of inflation would have been very challenging for consumers who have seen minimal wage increases in recent years.

A 3.5 percent rate of inflation would also have wrought havoc on interest rates. With rates on savings accounts under 1 percent, higher inflation would have meant that savers would have seen the purchasing power of their nest eggs eroded at an even faster pace. Also, with current mortgage rates barely above 4.1 percent, a 3.5 percent rate of inflation would have made such low rates almost certainly unsustainable, resulting in higher borrowing costs.

Thus, it came as a relief when the BLS announced that the CPI rose by just 0.1 percent, thanks largely to price declines in July across all components of the energy sector. That kept inflation for the past year at a manageable 2.0 percent, and set price increases back to a more moderate pace for the time being.

Implications for savings accounts and mortgage rates

What does this mean now for savings accounts and mortgage rates?

It is possible that a rise in inflation would have meant higher savings account rates, but this would have been a hollow victory if it came at the price of higher inflation. Now, more moderate inflation gives savings account rates a chance to close the gap against rising prices a little -- especially if banks start to raise their rates in response to a strengthening economy.

As for mortgage rates, the easing of inflation buys mortgage shoppers a little more time. Higher mortgage rates may be in the cards if the economy continues to gather momentum, but it will likely happen more gradually that way than if there were an inflation shock.

This moderate inflation scenario depends on energy prices continuing to moderate, and inflation not spreading to other sectors of the economy. For now though, consumers can celebrate good news on the inflation front.

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