Personal Finance Blog By MoneyRates - June 2009

A sharp move upward in intermediate bond yields last week left the market for certificates of deposit unmoved -- which is to say, stuck in low-yield territory. All things considered, savings accounts are looking like an attractive alternative to CDs.

At the beginning of Spring, there was a clear advantage just in making the small move out from a one-month to a 6-month CD. Now, the average 6-month CD is yielding less than a savings account, making it difficult to justify why you would want to lock up your money for the term of a CD. There can be an advantage to locking in an interest rate if rates subsequently fall, but at this time there isn't much farther for them to go down.

In contrast, while the average savings account is yielding a fairly modest 1.69%, there are a number of options offering over 2%. While you could do better if you were willing to extend out to a longer-term CD, this does not seem like the right time for a lengthy commitment -- not with interest rates so low, and with some hints of inflation on the horizon.

In short, a savings account is a good way to keep your powder dry while you wait for more attractive conditions -- but you should still shop around to get a higher yield while you wait.

After a sustained rally over the past three months, the stock market hit a bit of a speed bump in mid-June. Ironically, this is also bad news for investors in interest-bearing accounts such as money market and savings accounts, and even certificates of deposit.

The reason is that the stock rally had been accompanied by a sustained rise in Treasury bond rates. There are a couple of reasons for this. First of all, Treasury bonds are perhaps the most popular safe harbor for investors -- when the stock market gets too rocky, as it certainly did in 2008, investment dollars tend to retreat into bonds. This sends bond yields lower. When stocks rally, it tends to draw money away from the bond market.

In addition, the recent stock market rally has been bolstered by optimism about the economy, which in turn has brought on concerns about inflation. Inflation is kryptonite for bonds, so while stocks were rallying, bonds were retreating.

These trends reversed suddenly in mid-June, as bonds rallied while stocks faltered -- meaning that interest rates fell. It's too early to tell whether this is just a hiccup in the stock rally or the start of a new trend, but it could be a setback for interest rates as well as stocks. Treasury bonds represent market interest rates; these do not directly determine rates on things like savings accounts, but they are an indicator of where those rates may be going. That indicator had been pointing upward, but more recently, it has turned downward.

Treasury Secretary Timothy Geithner and National Economic Council Chairman Lawrence Summers recently outlined a proposal for financial reforms the Obama administration hopes to enact. At the center of the proposal are higher capital and liquidity requirements for banks, and more comprehensive oversight for complex financial institutions.

Fair enough -- but what does this mean to you?

As a bank depositor, these proposals could affect you in two ways, both of them good. Naturally, the grand design of this type of program is to make banks safer and more stable. While you may currently have FDIC insurance to fall bank on, it's much better never to have things get to that point. So, if the reforms are effective, you could rest a little more easily about your money market or savings accounts and your certificates of deposit.

A second, less obvious impact could be to push interest rates higher. Requiring banks to maintain more capital reserves and liquidity would put a premium on deposits and make lending tighter. Interest rates are affected by the supply and demand for capital, and these proposals would restrict the supply and create more demand. Eventually, this could result in higher interest rates for savings accounts and other deposits.

Two cautions though. First, these proposals are still a long way from becoming reality. Second, there was no shortage of financial regulation in place previously; ultimately, what matters is effective enforcement.

Government officials were cautiously optimistic about the implications of an announcement this week that 10 major banks would be paying back the emergency TARP funds they received during the banking crisis. The caution stemmed from the recognition that not all the problems banks face have been solved, while the optimism was a natural reaction to the fact that at least the situation has stabilized.

Ironically, in some ways the general economic turmoil has helped the banks. Savings rates have increased as consumers have reined in their spending habits, and people have fled riskier assets for the safety of insured bank accounts. As a result, deposits in commercial banks rose by half a trillion dollars in the year ending April, 2009.

All of this is a reminder of two key things depositors should remember:

• The banking system has a great deal of support. The government has taken extraordinary steps to backstop the system, and the return of some TARP money helps the government reload the resources it has at its disposal.
• Conditions vary greatly from bank-to-bank. Just as some banks were able to pay back TARP money before others, some banks are in a more aggressive mode than others when it comes to attracting new customers. For smart shoppers, this can mean higher interest rates by actively shopping around for savings accounts, certificates of deposit, and other bank offerings.

Federal Reserve Chairman Ben Bernanke's recent warning to Congress about the federal budget deficit was not misplaced, but it was a little curious. This deficit has been a long time in coming. While its growth has been accelerated by emergency measures to address the financial crisis, the seeds were sown when the government continued to run deficits right through the last economic expansion. If you can't balance the budget during good times, it's going to be really hard to control when a recession hits.

Bernanke's sudden concern about the deficit gives the impression of someone just waking up to a problem that should have been obvious long ago. Still, better late to the party than not show up at all.

Bernanke's immediate concern is with keeping interest rates low to stimulate the economy. Beyond that though, there is the risk that a runaway deficit will erode the credibility of the U.S. dollar, which would lead to inflation. The question is whether Congress will have the political will to address the deficit now, or whether they will wait till the dollar gets really punished before they act.

In the meantime, it is starting to be the worst of all interest rate environments for consumers. Rates on longer-term debt like mortgages are going up, while short-term rates on savings vehicles like certificates of deposit, money markets, and savings accounts keep getting lower. Stay tuned though -- conditions are volatile, so things can change quickly.