Personal Finance Blog By MoneyRates

Bad week for stocks spells hope for savers

August 7, 2014

| Senior Financial Analyst, CFA

Last week brought three major pieces of positive news for the U.S. economy. The stock market, however, acted as if it had seen a ghost.

In effect, perhaps the stock market did see a ghost -- the ghost of interest rates past. After all, a more robust economy is likely to end the era of super-low interest rates, and the transition back to more normal interest rate levels could be rocky for stocks. Depositors in savings accounts, on the other hand, would welcome that transition with open arms.

Three signs of momentum

Here are the three notable signs of positive economic momentum that appeared last week:

  1. GDP growth. First, on the morning of July 30, the Bureau of Economic Analysis released the advance estimate of second-quarter real GDP growth. After real GDP decreased at an annual rate of 2.1 percent in the first quarter, the initial estimate is that it grew at a 4.0 percent rate in the second quarter. This is not merely a return to positive territory. Four percent marks the type of healthy growth the economy has had trouble attaining since before the Great Recession.
  2. Improving Fed outlook. Later on July 30, the Federal Reserve released a statement summing up the conclusions of the latest Federal Open Market Committee. The Fed, which has been very cautious in nursing the economy along, acknowledged that economic activity rebounded in the second quarter, and that employment conditions were picking up as a result.
  3. Continued job growth. The improved outlook for jobs was further confirmed on August 1, when the Bureau of Labor Statistics (BLS) released its employment report for July. The BLS announced a net increase of 209,000 jobs in July -- the sixth consecutive month in which job growth has exceeded the 200,000 mark. Employment has not been able to sustain that kind of momentum for several years.

Better for savings accounts than stocks?

All this encouraging employment news should make for a great investment environment, right? Guess again.

The Dow Jones Industrial Average dropped by more than 300 points the day after the GDP and Fed announcements, and lost more than 100 points a few days later. Overall, the Dow has dropped nearly 700 points since July 22.

The stock market may be wrestling with its valuation levels after a sustained climb, but the real bugaboo is interest rates. Near-zero interest rates have boosted stock valuations, but those interest rates were a product of a chronically weak recovery. A healthier economy is likely to restore interest rates to more normal levels, which would put pressure on individual stocks to come through with earnings growth to drive price increases, rather than just ride the tide of low interest rates.

Savings accounts and other deposits, on the other hand, could badly use a return to interest-rate normalcy. It has been a bad five or six years for savings accounts, but the recent bad week for stocks could signal the beginning of better days for depositors.

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Inflation rides roughshod over savings accounts

July 25, 2014

| Senior Financial Analyst, CFA

At first it seemed like a temporary anomaly. Then it was something more than a blip, and now it seems as though it might be settling into a sustained trend.

Inflation appears to be off and running.

On July 22, the Bureau of Labor Statistics (BLS) reported that the Consumer Price Index (CPI) increased by a seasonally adjusted 0.3 percent in June. That may not sound like much, but it means that prices rose by more in one month than most savings accounts earn in a year.

Prices running away from savers

Measured on a monthly basis, inflation figures such as June's 0.3 percent increase often sound somewhat innocuous. However, June marked the third month in a row during which the CPI rose at an annual rate of well over 3 percent. In contrast, the inflation rate for the past year was just 2.1 percent.

Low inflation has been one of the few silver linings in the economic environment of recent years, though prices have generally been increasing much faster than the value of savings accounts and other deposits. If inflation exceeds 3 percent annually, savers will fall even further behind. Even if higher inflation eventually sparks a rise in interest rates, savings accounts have a long way to go just to catch up.

Inflation, of course, is just one measure of how the cost of living is increasing, and rising inflation could in turn make the cost of buying a house more expensive. Current mortgage rates are still just barely over 4 percent, but that is unlikely to last if inflation starts surging toward 4 percent.

Inflation of things, not wages

To make matters worse, recent price increases seem to be driven by commodity inflation, specifically in the energy sector. In other words, this is inflation in the price of things, not of wages, which makes it even harder for consumers to make ends meet.

According to the BLS report, gasoline prices rose by 3.3 percent in June alone, and by more than 6 percent in the second quarter of 2014. Meanwhile, there is still considerable slack in the labor market, despite recent job growth. This means that employees are seeing very modest wage increases. Most would have to string together a few years' worth of raises just to match the 6 percent that gasoline prices rose by in the second quarter.

As always, energy sector inflation is especially troubling because of the likelihood that it will spread to the many other sectors that depend on energy for production and distribution. With troubles involving the Middle East and Russia deepening, more upward pressure on energy prices may be in store.

There is some hope. Continued employment growth could bring stronger wage increases, and in time could even boost interest rates. However, it looks as though inflation has gotten the jump on wages and interest rates, meaning that the best paychecks and savings accounts can hope for is to play catch-up.

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Strong jobs report kicks off pivotal month for savers

July 9, 2014

| Senior Financial Analyst, CFA

The World Cup tournament represents roughly a full month's worth of action, with a busy slate of games bringing one dramatic development after another. July might prove to be a similarly action-packed month for economic news -- with the nation's savers one of the potential winners.

July kicked off with an encouraging announcement on employment growth, and by the end of the month, there should be a clearer picture of whether interest rates on savings accounts are finally ready to start heading higher.

Key economic announcements for depositors

With low interest rates being very much a function of the chronically weak economy since the Great Recession, the fortunes of interest rates and the economy overall are very much intertwined. Here are some of the key economic announcements slated for July that could impact interest rates on savings accounts and other deposits, as well as mortgage rates:

  1. Employment. On July 3, the Bureau of Labor Statistics announced net employment growth of 288,000 for June, making it the fifth consecutive month in which new jobs topped the 200,000 mark. After years of only sporadic growth, this is the most consistently strong run for the job market since before the Great Recession.
  2. Inflation. On July 22, the Bureau of Labor Statistics will announce the change in the Consumer Price Index for June. The backdrop here is that inflation has been accelerating over the past three months. If this continues, not only could it force interest rates up, but it might influence the Fed to be less cautious in unwinding its bond purchase program.
  3. Second-quarter GDP. July 30 will bring the initial estimate of second-quarter GDP growth. After the first quarter's steep drop in economic activity, this could be a pivotal announcement -- though after the first quarter's initial estimate was so far off the mark, it is also an announcement that should be taken with a grain of salt.
  4. Fed policy. July 30 will also bring the end of the next Fed meeting, which should tell us whether any or all of the above has caused any shift in monetary policy.

Just looking at the calendar, there is nothing unusual about this slate of announcements and events. However, it happens that all relate to economic developments that appear to be reaching tipping points of one type or another, and that's what gives this July the potential for special significance.

Outlook for interest rates

Despite the run of strong employment news, and despite the steady rise of inflation, interest rates on savings accounts have not budged so far this year, and current mortgage rates are 36 basis points below where they ended 2013. As with goals in a World Cup game, upward movement in interest rates may take a long time coming and may be the result of a steady build-up of cumulative pressure.

When they finally come though, those interest rate increases, again like World Cup goals, could be dramatic and decisive, so stay tuned to the action in July.

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The biggest threat to the housing recovery

June 26, 2014

| Senior Financial Analyst, CFA

Last Sunday, the U.S. men's soccer team saw a possible victory over Portugal disappear in the final seconds of a World Cup game. That kind of sudden, cruel twist has also become common in the economy over the past several years.

For that reason, despite a run of positive economic news that most recently includes a surge in new home sales, you have to be prepared for the possibility of a setback. If all goes well, the economy could be on track to restoring housing values, putting people back to work and bringing interest on savings accounts and other deposits back to a respectable level. But there are still plenty of factors that could disrupt things.

New home sales rise

The economy has been on a roll lately, and on June 24 the Census Bureau and Department of Housing and Urban Development announced that new home sales had surged by 18.6 percent in May. This gain is especially significant because housing sales had been essentially treading water over the prior year up to that point, and it remained to be seen whether the housing recovery was strong enough withstand last year's rise in mortgage rates.

This announcement puts May's new home sales 16.9 percent ahead of where they were a year earlier, despite the fact that current mortgage rates are about 60 basis points higher than they were in May 2013. In other words, the housing recovery is finally showing some staying power.

Couple this with strong employment growth in recent months, and things are going well. Where could an upset come from?

A stealthy attack

In that U.S. men's soccer game, the late counter-attack that led to Portugal's equalizing goal seemed to come out of nowhere. But the source of the scoring pass should have been no surprise -- it came from Cristiano Ronaldo, the reigning world player of the year.

Similarly, though economic upsets often take people by surprise, the source tends to be something that should have been somewhat predictable. In this scenario, the most likely suspect -- the player to keep your eye on -- may be inflation.

The inflation rate has already increased in each of the past three months. Now with conflict in the Middle East widening, higher oil prices could put more upward pressure on inflation.

While the Federal Reserve has been concerned about inflation being too low, higher inflation from rising oil prices would not be the solution they would like. Rather than being a sign of rising demand, it would represent the kind of commodity inflation that squeezes consumers and businesses alike, and ultimately suppresses broader economic activity. As for savings accounts, their interest rates might rise in such a scenario, but probably not enough to keep pace with inflation.

So, from home sales to employment, things seem to be going well for the economy. But keep your eyes on inflation. If something is going to mess this up, it's as likely a culprit as any.

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May employment figures raise hopes for higher deposit rates

June 12, 2014

| Senior Financial Analyst, CFA

It is no secret that a weak economy is largely to blame for today's low interest rates on savings accounts and other deposits. On the whole, things have not gotten any better so far in 2014. However, the most recent employment report suggests that things may be turning around for the economy.

While that does not augur an immediate improvement in savings account rates, it does set the stage for rates to move higher eventually -- if the recent employment trend can continue.

Turning the economy around

The economy began 2014 on a sour note. Job growth in both December and January was sub-par, and real GDP growth turned negative in the first quarter, according to the most recent estimate from the Bureau of Labor Statistics (BLS). This raised the possibility that the economy might be slipping back into recession.

However, the employment trend more recently suggests that the economy is growing again. On June 6, the BLS released its monthly jobs report for May. While job growth during the month did not represent a dramatic breakthrough, May was the fourth consecutive month in which net job creation exceeded 200,000. That might seem like a modest achievement, but the last time there have been so many months in a row with 200,000 or more new jobs, Bill Clinton was in the White House.

This job creation figure is an especially significant economic indicator. For one thing, it is more meaningful than the percentage unemployment rate, because that is affected by how many people are officially looking for work. If job growth stays strong for long enough, the unemployment rate will take care of itself. Also, job creation is not just a sign of economic health and optimism, but it represents new fuel for the economy, in the form of paychecks for all those people going back to work.

Calming the Fed?

With the Federal Reserve's Open Market Committee meeting next week, it will be interesting to see if job growth and other economic data have been strong enough to calm a recent worry of both the Fed and the European Central Bank, which is deflation.

For most of recent history, the Fed's concern has been with keeping a lid on inflation. Now, however, they are concerned that it is too low. Deflation is not only a sign of anemic pricing power, but it can also become part of an ugly spiral as consumers defer purchases in hopes that prices will be lower in the future. However, with rates on savings accounts near zero, the last thing depositors want is a campaign to artificially pump up inflation while the economy itself is still sputtering.

Hope for savings accounts?

If higher inflation with a weak economy represents the lose-lose scenario for savings accounts, the win-win would be faster growth with low inflation. The last time the U.S. saw that combination of conditions was in the late 1990s. Perhaps the recent stretch of 1990s-style job growth is a sign that this history can repeat itself.

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