Personal Finance Blog By MoneyRates
March 6, 2014
It is difficult to write about the developing situation in the Ukraine while the wheel is still very much in spin, but no event so far this year threatens to have as big an impact on the economy and investments as Vladimir Putin's attempt to exert control over his smaller neighbor.
As things stand now, Putin seems to have backed off incursions into the Ukraine beyond the Crimean region. The latter remains under his effective control, however, and seems headed toward breaking away from the rest of the Ukraine as either a separate, Russian-aligned state or part of Russia itself.
Unless there is some dramatic, peaceful reversal of the situation, here are some possible economic outcomes:
- A drag on global growth. The European Union and the U.S. are threatening economic sanctions against Russia, and Russia is threatening economic retaliation. That typically means slower growth all round.
- The specter of inflation. Russia already has made a habit of using its gas exports to Europe as economic blackmail. Ramping up that tactic would be inflationary, and oil supplies could also come into play if the conflict escalates.
- Other storm clouds. China has long threatened to act on its territorial disputes with Japan and Taiwan. If Russia gains Crimea virtually without bloodshed, what is to discourage China from asserting its claims in a similarly aggressive manner?
The Russian stock market fell sharply in immediate reaction to the crisis. If investors continue to flee, that may be the strongest incentive for Russia to moderate its position.
Impact on stocks, bonds and savings accounts
The U.S. stock market's reaction to all this was wildly negative one day, than bizarrely euphoric the next. The first reaction may have been more on the money.
Unless Putin pulls all the way back from the brink -- that is, not only withdraws Russian troops but also stops supporting separatists in Crimea -- this situation is going to have consequences. Sanctions will be exchanged, and the world will anxiously await the next land grab, whether by Russia or some other nation.
As noted above, the economic consequences are likely to be slower growth and higher inflation. That is a bad recipe for stocks, bonds and savings accounts:
- For stocks, slower growth will keep a lid on earnings. Meanwhile, a rise of inflation will hurt stock valuations by pushing up interest rates.
- For bonds, rising inflation would mean rising yields. Bond yields only rise one way: by having prices fall.
- Savings accounts have not even been able to keep up with a low rate of inflation. The situation in the Ukraine could accelerate inflation, while slower growth would continue to hold bank rates back.
Ever since the financial crisis and the Great Recession, the global economy has been in a fairly fragile state. To twist an old simile, Putin's adventures in the Ukraine may prove to be like letting an angry Russian bear into a china shop.
February 21, 2014
So far, the month of February has seen the stock market rally impressively, while the value of the U.S. dollar has slipped. Are currency traders and stock market investors reading different newspapers?
As inconsistent as the actions of U.S. stocks and the dollar might seem, they have a root cause in common: weakness in the U.S. economy.
A currency trader's perspective
Some speculate that the accumulating evidence of weakness in the U.S. economy will force the Federal Reserve to prolong its easy monetary policies. From a currency trader's perspective, aggressive monetary stimulus does two things: It lowers interest rates, and it erodes the creditworthiness of the government. Both of these reduce the attractiveness of the dollar.
The dollar's slide might be more pronounced, except that other economies are so dependent on the U.S. as a trading partner that what is bad for the U.S. generally touches other nations as well.
The stock market's perspective
While the dollar has stumbled, the U.S. stock market has regained just about all the ground it lost in January. Why is Wall Street so happy? Because those same low interest rates that undermine the dollar help to boost the relative attractiveness of stocks. In fact, in many cases the weak dollar is a bonus to U.S. companies, because it improves their pricing position relative to foreign competitors.
Perhaps the biggest short-term win for the stock market may come with the Federal Open Market Committee's next meeting in mid-March. That's when the Fed will announce whether it will continue to taper back its quantitative easing program. If the weakening economy forces the Fed to slow down the tapering schedule, it will signal that low interest rates are here for a while longer.
Ultimately though, stock investors may regret getting too exuberant over low interest rates that are a result of a weak economy. Low interest rates may improve the relative value of company earnings, but ultimately those earnings have to grow for a stock to make sustainable progress. In a weak economy, earnings growth will be hard to come by.
It's unanimous: Savings accounts lose
While the dollar is going down and the stock market is going up, both reflect the same thing -- more downward pressure on interest rates.
This means that savings accounts join the U.S. dollar among the losers in this situation. Not that interest rates on savings accounts are likely to drop -- they are already so close to zero that is hardly possible. However, any hope of them finally rising in the first half of this year is quickly vanishing.
Of course, home buyers and home owners may benefit from lower mortgage and refinance rates. However, the boost from lower rates may be negated if the deteriorating economy makes loans harder to come by. Mortgage shoppers and stock market investors may find that a weakening economy is not good news for anybody in the long run.
February 7, 2014
The first business day in February brought more bad news about the economy. Following disappointing data in January on employment growth and the housing market, the manufacturing sector kicked off February with more signs of slower economic growth.
This raised the question of whether the Federal Reserve mistimed its decision to go ahead with tapering its quantitative easing program in its recent meeting, rather than holding off until the economic signals are clearer.
Manufacturing sector is latest disappointment
On February 3, the Institute for Supply Management (ISM) released its Manufacturing Report on Business for January. This report, based on a survey of manufacturing supply managers, indicates that the manufacturing sector of the economy is still growing, but at a sharply slower pace than previously.
Signs of slowing growth appeared across a variety of indicators from the ISM survey. The overall Purchasing Manager's Index declined by 5.2 percentage points in January. Especially troubling for future months, the New Orders Index declined even more drastically, with a 13.2 percent drop. Production and employment also reported lower figures.
Like the disappointing jobs and housing reports previously, the disappointing manufacturing report was blamed by some on bad weather. Although the weather has been unusually harsh this winter, it is important to remember that most economic data is seasonally adjusted. In short, weather is taken into account to some extent, so there may be deeper problems here than the polar vortex.
What is the Federal Reserve seeing?
Though the manufacturing report was not out yet when the Fed met in the last week of January, the weak employment and housing data were. Despite that, the Fed decided to continue to taper back its quantitative easing program, on the grounds that "economic activity picked up in recent quarters."
That's a narrative that seemed true until December and January data started to come out. The financial markets certainly feel recent signals are troubling. The S&P 500 has dropped by about 5 percent so far in 2014. Meanwhile, 10-year Treasury bond yields have dropped by about 40 basis points since the end of 2013. The steep downward trajectory of bond yields continued despite the Fed's decision to cut back monthly bond purchases by another $10 billion -- a decision that under normal circumstances would be expected to send bond yields higher, not lower.
Translating those bond market rates into consumer interest rates means good news for borrowers, and bad news for savers. Current mortgage rates are some 21 basis points below where they were the first week of January. That is good news for anyone looking to take advantage of low home purchase or refinance rates.
On the less happy end of the spectrum, the accumulation of discouraging economic news means continued low rates for savings accounts, CDs and money market accounts. Their future depends on whether the Fed's apparent optimism is more accurate than the stock market's recent pessimism.
January 24, 2014
Steady growth with low inflation is an ideal that the economy has not achieved consistently since the late 1990s. Toward the end of 2013, things seemed on track for a return to that environment -- until January brought some chilling news on both fronts.
Two economic announcements in mid-January, less than a week apart, suggested that far from steady growth and low inflation, the economy recently saw slowing growth and rising prices. Steady growth and low inflation is the perfect prescription to cure the ailing level of savings account rates, so the prospect of the opposite environment is more bad news for depositors.
New doubts about the job market
The first sign of trouble came on January 10, when the Bureau of Labor Statistics released its employment report for December 2013. After averaging more than 200,000 over the previous four months, job growth for December dipped sharply to just 74,000. That number is not just a little below trend -- it is the lowest monthly number since January 2011, and it was bad enough to drag 2013's average monthly job growth down to 182,000. This is slightly below 2012's job creation rate of 183,000 per month, raising the question of whether last year's apparent economic progress was just an illusion.
The inflation picture
Bad news on the job front was followed on January 16 by a report that the Consumer Price Index posted its biggest increase in six months during December. This came after inflation had been negative in October, and flat in November.
Inflation for the past year was still just 1.5 percent, a very mild number. Still, with rates on savings accounts already trailing even that mild inflation rate, the last thing depositors can afford is for the pace of inflation to start picking up. This would mean depositors losing purchasing power more quickly.
A look ahead
Of the two problems -- weak employment and rising prices -- the slump in the job market is probably more serious right now. Inflation numbers can be a bit skittish from month-to-month, but oil prices, one of the most important components of inflation, has generally behaved well in recent months. These prices flared up a bit in December, which was a leading reason why the overall inflation number was a bit higher, but oil has since settled back down and as of mid-January was pretty much at the same price as a year earlier.
A weakening in the job market, however, could be more problematic. Under current conditions, this is perhaps the key indicator of the economy's strength. Unless economic prospects improve, banks are unlikely to see enough demand for capital to justify raising rates on savings accounts and other deposits, and the Federal Reserve will be likely to prolong its low-interest-rate policies.
Last year brought higher interest rates for mortgages, but not for savings accounts. This could be the year that savings account rates follow mortgage rates higher, but so far the year is not off to an encouraging start.
January 10, 2014
With 2013 over, the final tally on bank failures during the year shows that the banking system continues to make significant improvement. But is this a sign of lasting reform, or simply a cyclical upswing?
Twenty-four banks failed in 2013, less than half the number of casualties in 2012, and the third consecutive year of improvement. Two statistics really put those 24 bank failures in perspective, for better or worse:
- There were 140 bank failures in 2009 and 157 in 2010, so 24 is a marked improvement.
- There were just 21 bank failures in total from 2002 through 2007, so the system still is not as healthy as it was before the financial crisis.
What this comes down to is a system that has made significant improvement, but still needs to get better. This is of vital importance to bank customers. Although all deposits up to $250,000 are insured by the FDIC, consumers benefit when there are fewer bank failures.
How bank failures impact consumers
To begin, fewer failures mean fewer customers have to go through the delays and disruptions involved in having their banks taken over by the FDIC. Most people don't like to change banks anyway, and having to change under duress is especially inconvenient.
Also, the money the FDIC uses to insure deposits comes from financial assessments the FDIC makes on all banks in the system. The more the FDIC has to tap into the insurance reserve, the higher it has to raise assessments on the remaining banks. These higher costs are in turn likely to be passed along to customers in the form of higher fees on checking accounts, lower interest rates on savings accounts or both. When there are fewer failures, it eases this cost pressure.
Finally, getting failures under control signals that the system as a whole is more stable. As valuable as the FDIC and the Federal Reserve are in stabilizing that system, when things are deteriorating conditions can reach a tipping point where they become unmanageable. The more bank failures decline, the further the system pulls back from that tipping point.
The remaining question is: Will this improvement continue?
Cyclical or systemic improvement?
While regulatory reforms have been put in place and both bankers and regulators can be assumed to have learned lessons from the last crisis, the banking system has also had some cyclical conditions in its favor:
- The housing market has improved. This has stemmed the tide of foreclosures and bolstered the value of mortgage lenders' collateral.
- Employment has picked up. More economic activity means more lending demand and fewer defaults.
- Interest rate spreads have widened. A wider spread between rates on loans and those on savings accounts means higher profits for the banks.
The reduced number of bank failures in 2013 was certainly a positive sign. It will only be clear how positive once the system is really tested again, either by the next economic downturn or by a new crisis, such as the mounting problems with student loan debt.