Personal Finance Blog By MoneyRates

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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Bad week for stocks spells hope for savers

August 7, 2014

| MoneyRates.com 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

| MoneyRates.com 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

| MoneyRates.com 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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