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Personal Finance Blog By MoneyRates

Reconciling the stock market and the economy

January 14, 2015

| MoneyRates.com Senior Financial Analyst, CFA

The last major piece of economic news to come out of 2014 was an unexpectedly strong upgrade to the GDP growth estimate for the third quarter. So how did the stock market respond to this happy development? By starting 2015 with five-day losing streak.

As is often the case, reconciling the behavior of the market with the apparent economic environment takes some explanation. Trying to understand it is important though, because it can have implications not just for stock investors, but for bond investors and depositors in savings accounts too.

When good news is not good enough

Here are some reasons that good news on the economy has not been enough to buoy the stock market in recent days:

  1. Valuation. The stock market has now risen in five of the last six years, and that sixth year was essentially flat. Though the economy seems to be hitting its stride now, for much of that time the market was thriving while growth was sputtering. In short, sometimes prices get a little ahead of conditions, and overvalued markets are always subject to corrections.
  2. Anticipation. Markets are forward-looking, and while the revision to the third-quarter GDP number was good news, by now it is somewhat old news.
  3. Monetary policy. Federal Reserve policy in recent years has created a market addiction to low rates. At any sign that growth is becoming too robust, the stock market gets jittery that the Fed will raise rates.
  4. Global influence. The U.S. economy does not operate in isolation, and while things seem to be revving up at home, growth is grinding to a halt in much of the world.
  5. Disruptions. Changes that are sudden and severe tend to disrupt markets. In this case, the disruption comes from plunging oil prices. A more moderate drop in the price of oil, or even a long, orderly descent, would probably have been welcomed. However, a 50 percent drop in about half a year can be disruptive geopolitically and to a financial system that has heavy investments in oil drilling.

For any or all of these reasons, stock investors have started heading for the exit. The question is, where should they go from there?

Seeking alternatives

What is especially tough about the recent market setback is that attractive alternatives are hard to find these days. The flight to quality in reaction to the market's woes sent bond yields plunging -- the yield on 10-year Treasuries dropped below 2 percent for the first time since May 2013. Rates on savings accounts and money market accounts were already close to zero, and these conditions could prolong their stay in the cellar.

In other words, there is not an obvious alternative to the stock market where you can park your money and earn a decent return. Then again, if the market has begun a prolonged slump, people may find that breaking even in their savings accounts is not so bad after all.

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Job growth spells hope for deposit rates in 2015

December 18, 2014

| MoneyRates.com Senior Financial Analyst, CFA

The latest employment report from the Bureau of Labor Statistics (BLS) indicates that the U.S. job market is having its best year since 1999. That's good for workers and the economy as a whole. As for the impact on interest rates, it may lead to a reversal of the conditions consumers have experienced for some time.

While 2014 has been a good year for mortgage rates, it's been not so good for savings accounts and other deposits. If the employment trend has any influence though, next year might see things get tougher for home buying and refinance rates, but more rewarding for depositors.

A banner year for new jobs

On December 5, the BLS announced that 321,000 new jobs were created in November. As a bonus, the same report upgraded job creation for the prior two months by a total of 44,000, bringing the new tallies for September and October to 271,000 and 243,000, respectively.

All three of those monthly totals exceeds the average for the past 12 months of 224,000. November's 321,000 is the best single month in nearly three years, and brings the total for 2014 so far to 2,650,000 new jobs. That's the most for any year since 1999, with one month still to go.

Perhaps what is as striking as the raw total is the consistency that job creation has finally achieved. Prior to this year, the job market had failed to exceed 200,000 new jobs for more than three straight months in over a decade. Now, it has reeled off 10 such months in a row.

The best kind of inflation

Over the past year, steady job growth has brought the unemployment rate down by 1.2 percent, to 5.8 percent. There may be some slack in that number in the form of part-time workers and people who have dropped out of the job market, but if job creation continues to improve, the slack in the job market will gradually be taken up.

All of this is naturally good for the economy because it means putting people back to work, and if the unemployment rate gets down to around the 5 percent mark, employees should also start to see bigger wage increases as well. This will help repair some debt-laden balance sheets and put more dollars back into the economy.

That kind of wage pressure could also push inflation a little, but it comes at a time when inflation generally has been considered too low rather than too high. It would be perhaps the best kind of inflation -- one where the increases go straight into people's paychecks.

Impact on bank rates

Mortgage rates fell in 2014, while rates on savings accounts stayed near zero. With stronger demand and perhaps higher inflation, things could be very different in 2015.

Of the two, mortgage rates are likely to be first to react to any whiff of new inflation. However, if job growth continues to grow, 2015 could also be the year beaten-down savings accounts finally get up off the mat.

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Inflation stall brings mixed holiday blessings for consumers

December 8, 2014

| MoneyRates.com Senior Financial Analyst, CFA

Last month's Consumer Price Index release revealed that inflation has virtually disappeared in recent months. Not everyone welcomes this, but consumers should find plenty to like about near-zero inflation.

The CPI was essentially unchanged in October, meaning that prices generally neither rose nor fell. This brings inflation for the past year to just 1.7 percent, which is below the Federal Reserve's stated target of 2 percent.

If the recent trend holds, the year-over-year inflation rate could drop even further. Thanks partly to a decline in the CPI during August, prices for the second half of 2014 so far are more or less flat.

What could change the inflation trend

While August's deflation seems like an aberration, near-zero inflation seems to have firmly established itself. What could change this trend? Inflation is sensitive to a variety of shocks, but for now keep your eye on two chief suspects:

  1. Federal Reserve policy. The Fed's concern with the inflation environment is not just that the lack of price increases is a symptom of weak growth, but that it could further encourage consumers to defer their purchases, since they have nothing to lose by waiting if things are not getting more expensive. Persistently low inflation could spur even looser monetary policy in an attempt to boost prices.
  2. Oil prices. The recent low inflation trend is largely due to declining oil prices. This is not likely to be a sustainable trend, and history shows that when oil prices change, they can do so suddenly and drastically.

Despite these potential forces for change, inflation is very much momentum-driven. In the 1970s and early 1980s, high inflation seemed an insurmountable problem. Today, for better or worse, near-zero inflation seems to have settled in over the past few years. Though not everyone is thrilled about disinflation, most consumers will probably find a reason to cheer.

Impact on consumers

Bank deposit customers may cringe at the thought of interest rates on CDs, savings accounts and money market accounts remaining at current low levels for the foreseeable future. However, seeing inflation continuing to shrink has several positives for consumers:

  1. Current mortgage rates continue to make housing affordable for new home buyers.
  2. Low refinance rates are creating much-needed breathing room in the budgets of existing homeowners.
  3. Lower prices at the pump provide relief for millions of Americans who rely on their cars or trucks for their livelihood.
  4. Lower prices generally take some of the sting out of the anemic pay growth Americans have seen in recent years.
  5. Even those beleaguered deposit account customers have more of a fighting chance at finding rates that will beat inflation when price increases shrink to nearly nothing.

The Federal Reserve has consistently expressed concern about low inflation, as both a symptom and a cause of economic weakness. For consumers though, having prices ease just in time for the holiday season seems like a welcome gift.

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Job growth sustains hope for savers

November 14, 2014

| MoneyRates.com Senior Financial Analyst, CFA

The latest figures from the Bureau of Labor Statistics (BLS) show that strong U.S. job growth continued through October. This is obviously good news for people looking for work, but it could also have much wider benefits -- including help for consumers with savings accounts and for mortgage shoppers.

The BLS report indicated that 214,000 new jobs were created in October, lowering the unemployment rate to 5.8 percent. However, perhaps the most significant aspect of this jobs report was beyond the headline numbers. The report also included an upward revision of August's job growth number, from 180,000 to 203,000.

That means that job growth has now exceeded 200,000 for nine straight months. That is the longest stretch of monthly job growth in excess of 200,000 since a run of 19 such months from late 1993 through early 1995.

The improving strength of the job market can also be seen in the changing characteristics of the labor force. Over the past year, the number of long-term unemployed (people out of work for 27 weeks or longer) has declined by 1.1 million (a drop of 27.5 percent). Over the same period, the number of people working part-time rather than full-time for economic reasons dropped by just less than a million (12.3 percent).

Two potential positives for bank customers

The direct benefit of job growth is clear -- putting people back to work helps those individuals and their families get by. However, there are broader, knock-on effects of employment growth that help a much wider swath of the population, including customers of savings accounts and mortgage products:

  1. Consumers with savings accounts could benefit from higher interest rates. It has been a long wait since rates on savings accounts dropped to nearly zero. The key behind that wait has been the fragile state of the economy. Increased economic activity would give banks more productive ways to deploy the deposits they have on hand, by making profitable loans and investments. Employment growth helps spur this activity by broadening the base of wage-earning consumers, and injecting more income into the economy.
  2. Mortgage shoppers may benefit from wider loan availability. Current mortgage rates may still be among the lowest in history, but lending standards have been so tight they have only been available to extremely well-qualified borrowers. While a stronger economy may come a a price to mortgage shoppers in the form of higher rates, it is better to pay a little more and be able to get a mortgage than to have low rates in theory but have loans unattainable to many would-be borrowers.

The prevailing skepticism that has surrounded the economy in recent years has muted the immediate impact of positive employment news. However, the defining characteristic of the recent employment trend is not just that it has been good, but that it has been consistent. It is this consistency that could ultimately put both the economy and the financial markets on firmer ground.

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Did inflation hit the 'sweet spot' in September?

October 31, 2014

| MoneyRates.com Senior Financial Analyst, CFA

Like Goldilocks looking for porridge that was "just right," financial markets struggle to accept large monthly fluctuations in inflation. However, the September figure released last week may represent the kind of happy medium investors want.

The Consumer Price Index (CPI) for September showed that inflation rose by a seasonally adjusted 0.1 percent during the month -- a figure that may fall into the "just right" zone, especially when compared to the swings in inflation in the months that led up to September.

A welcome calm

Earlier this year, inflation appeared to be on an upward track. March, April and May saw monthly inflation numbers of 0.2, 0.3, and 0.4 percent, respectively. That not only represented a troubling trajectory, but it left inflation running at an annual pace of nearly 5 percent.

Inflation eased back in June and July, and then in August reversed course altogether. The CPI declined by 0.2 percent, hinting at the kind of deflation that is symptomatic of a failing economy. In this context, seeing a positive but mild inflation number for September may have been the best outcome possible. The latest reading puts inflation at the easy-going pace that has made low-interest-rate policies possible, but without the deflation scare.

What investors want

These inflation developments are occurring during a tumultuous time for the stock market. At one point, the Dow Jones Industrial Average was down by more than 5 percent during October, but it has since recovered to about the breakeven point for the month.

Among other things, last week's inflation report seems to have had a positive effect. As news of global economic weakness grows, any repeat of August's deflation would have reinforced suspicions that global weakness had started to drag down the U.S. economy. That's why a rise in the CPI was actually welcome news to stock market investors.

Here is where the "just right" balance comes in. Deflation would almost certainly have spooked investors, but they also would not have welcomed a high inflation figure. Investors want solid economic growth, but they want interest rates to remain low -- something that would be virtually impossible if inflation flared up. That is why 0.1 inflation seems to have been just right.

The outlook for savings accounts

To some extent, people with savings accounts, CDs and money market accounts are seeking the same balance between steady growth and low inflation. The important difference is that they do not want artificially low interest rates to continue.

From the perspective of savings accounts, "just right" represents an economic growth rate that is strong enough to allow interest rates to rise to more normal levels, but not so strong as to stir up inflation.

What is clear so far is that on balance, inflation was virtually nonexistent during the quarter. Now, depositors just have to hope that economic growth did not disappear along with it.

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