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Personal Finance Blog By MoneyRates - January 2013

What will the end of Bernanke's term mean?

January 28, 2013

| MoneyRates.com Senior Financial Analyst, CFA

A new poll indicates that two-thirds of economists expect that Federal Reserve Chairman Ben Bernanke will not return to that post for a third term. With the end of his current term due to expire in about a year (January 31, 2014), it's not too early to begin examining what a change in leadership at the Fed might mean for interest rate policy.

A CNNMoney poll released last week found that although two-thirds of respondents believe another term for Bernanke isn't in the cards, most believe it would be helpful to the economy if he were to return. If he leaves, it could open the door for a number of outcomes.

Should he stay or should he go?

Many of the economists surveyed believe it will be Bernanke's choice whether he serves a third term. Here are three scenarios that could result if Bernanke leaves:

  1. Bernanke's departure would be bad because markets hate uncertainty. Whatever you think of Bernanke's decisions, it would be hard to argue that he hasn't been fully committed to his policies in response to a very challenging situation. A certain predictability is calming to the financial markets. Until the markets gain that kind of comfort level with Bernanke's successor, speculation about the future direction of Fed policy could cause some volatility. Political wrangling over the nomination and confirmation process could stir things up even more.
  2. His departure would be a welcome change because his policies have had dubious results. On the other hand, if Bernanke's low-interest-rate policies haven't worked by 2014, might it not be time for a change? While current mortgage rates have helped prop up the housing market, what has never been fully addressed is the economic impact of the income that has been lost by reducing interest rates on savings accounts and other deposits to nearly nothing.
  3. It's won't matter either way because Bernanke isn't a one-man band. While the Fed Chairman is the point person for presenting and defending monetary policies, he doesn't work in isolation. Those policies are decided on by the Federal Open Market Committee, which has 12 members (including the Chairman). While this committee hasn't been unanimous in supporting recent policies, they have operated with a pretty broad consensus.

The extreme low-interest rate policies of the current Fed were designed to apply temporary stimulus to an economy in crisis. Those polices have evolved into increasingly longer-term commitments as growth has remained sluggish. Eventually though, current levels of interest rates will likely prove unsustainable and rates will have to be restored to more normal levels.

Engineering a restoration of normal interest rates without creating too big of a drag on the economy could be the biggest challenge of the next term for the Fed Chairman, whether it's Bernanke or someone else. As significant as the Chairman's post is, often it is conditions that really dictate policy.

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Inflation exits the year with a whimper

January 17, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Inflation took a breather in the fourth quarter. If it continues to relax, it might actually create some breathing room for savings accounts and other deposits.

The Bureau of Labor Statistics announced yesterday that the seasonally adjusted Consumer Price Index was unchanged for the month of December. That meant that consumer prices actually declined overall during the fourth quarter, and were up only 1.7 percent in 2012.

A crucial relationship with savings accounts

That 1.7 percent is considered low by historical standards of inflation, but it still exceeds current interest rates on savings accounts and other deposits. This highlights the crucial relationship between inflation and interest rates. In terms of whether a depositor is really gaining or losing purchasing power, interest rates cannot be viewed in isolation. They have to be viewed relative to the level of inflation.

This relationship is complicated by the fact that rising inflation can push interest rates higher. On the surface, that might seem to be good for interest rates, but it actually represents no progress at all. Indeed, if interest rates lag behind the rise of inflation, those rates could go up and still be worse off.

The flip side of this is that low inflation can lead to falling interest rates, especially when the lack of inflation is a symptom of economic weakness. However, interest rates are currently so low they don't have much further to fall. Therefore, having prices decline in the fourth quarter was good for depositors, because it gave them a rare chance to come out ahead of inflation -- even with most interest rates below 1 percent.

The outlook for inflation

Getting ahead of inflation for just a few months doesn't really help depositors that much, so the key question is, what's next for inflation? Here are three reasons to be concerned that inflation could make a comeback in 2013:

  1. The fiscal cliff deal was more stimulative than budget-friendly. The resulting boost in the economy could lead to higher prices.
  2. Oil prices are always just a crisis away from the next spike. Inflation has a way of following the lead of oil and gas prices. These have been declining in recent months, but how long can that last?
  3. Unusual weather conditions are creating challenges for farmers. The climate seemed to deal in extremes last year -- either floods or droughts. If this continues, it could disrupt the food supply, leading to higher prices.

For now, the easing of inflation in recent months has left a little room for CD, savings and money market rates to get ahead of rising prices -- especially for those bank customers who actively pursue higher interest rates. Even so, depositors will have to keep a wary eye on inflation, because today's extremely low interest rates still leave deposit accounts vulnerable to any uptick in prices.

Posted in: Savings Accounts

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Flickers of hope emerge for deposit rates

January 11, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Last Friday, employment growth for December was announced at 155,000 new jobs. This was a good but not great showing for the job market, which largely sums up the economy for 2012. The question is, what kind of year does that set up for 2013?

The U.S. economy continued to grow throughout last year, but not strongly enough to give any lift to CD, savings and money market rates. December's job growth was a good example. The Bureau of Labor Statistics announced that 155,000 new jobs were created in December. This was about in line with November's job growth of 161,000, a number that benefited from an upward revision of 15,000 in the latest report.

This level of job growth indicates that the economy is not slipping into a recession, but has not yet generated enough momentum to make a serious dent in unemployment and drive interest rates upward. What's left now is to look ahead rather than backward.

Growth and the fiscal cliff

Perhaps the most encouraging thing about December's employment growth is that it took place in the shadow of the fiscal cliff. Uncertainty is bad for business conditions, and it would have been natural for employers to put off hiring plans until the fiscal crisis was resolved.

If the economy managed 155,000 new jobs despite that huge uncertainty, it creates hope for what kind of job growth will come in January, after at least one major aspect of the fiscal cliff -- the tax question -- had been resolved. The stock market certainly reacted favorably in the immediate aftermath of the tax deal. The question now is whether employers will show similar optimism in their hiring plans.

Impact on the Fed

Besides the general state of the economy, another important influence on interest rates is the Federal Reserve. The Fed has made it clear that it will do everything it can to keep interest rates low as long as the economy is weak, and the key aspect of the economy the Fed is focused on is employment.

December's employment growth was not enough to budge the unemployment rate from 7.8 percent. It will take stronger growth to lower that number, and a sustained period of such growth to get unemployment down to the 6.5 percent target the Fed has set for the threshold at which it would start to back off from its low interest rate stance.

Outlook for savings accounts

Because of the Fed's policy, and because growth generally gives banks more incentive to offer higher interest on deposits, a stronger economy is the key to whether rates on savings accounts rise in 2013. Between a decent employment number for December and a stimulus-friendly tax deal, recent weeks have brought some optimistic signs for savings accounts.

The key to 2013 will be whether growth can start to gain momentum. The first real sign of that will come with the January employment report, which will be released in early February.

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Why the fiscal cliff deal could lift interest rates

January 7, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Congress and President Obama may have reached a deal to avoid the fiscal cliff, but the agreement still leaves some key questions about government finances unanswered. As things stand now, a number of factors suggest that mortgage rates and interest on savings accounts could move higher by the end of 2013.

What the deal accomplished

The most prominent aspect of the deal to avoid the fiscal cliff is that it preserved the Bush-era tax cuts for most Americans -- only individuals making more than $400,000 a year and households making more than $450,000 a year will see their federal income tax rates rise. Wealthy Americans will also pay more in capital gains and estate taxes under the agreement, while more people will be able to avoid the alternative minimum tax, which means that those people will be able to take better advantage of tax deductions. The deal also delayed a round of automatic spending cuts that was due to go into effect January 1.

The immediate goal of this deal was to avoid snuffing out an already fragile economic recovery. Most experts agreed that the economy was not growing at a strong enough rate to overcome the drag on growth that result from a combination of widespread tax increases and federal spending cuts.

What the deal didn't accomplish

The deal did not completely spare the average taxpayer. A temporary break on Social Security taxes was allowed to expire, meaning that most people will see a small hit to their paychecks from now on.

Perhaps more significantly in the long run, the deal did little to address the looming problem that inspired the fiscal cliff in the first place -- the growing federal budget deficit. The Congressional Budget Office estimates that the deal will add $4 trillion to the deficit over the next 10 years.

The budget deal also failed to address the country's debt limit, which sets up another confrontation between Democrats and Republicans within a couple of months. Between that and the fact that the fiscal cliff's spending cuts have only been delayed rather than cancelled, it means that the economy may yet have to withstand some level of spending cuts.

The impact on interest rates

Because the budget deal leaned more toward economic stimulus rather than deficit reduction, it could help reverse the trend that has seen interest rates decline drastically over the past few years. That's bad news for potential borrowers, but good news for depositors who have seen interest on their savings accounts and other deposits all but disappear.

Anything that stimulates the economy has the potential to increase the demand for capital, which creates upward pressure on interest rates. It could also help bring unemployment down, which would hasten the day when the Federal Reserve can back off on its current policy of active intervention to lower interest rates. In addition, because the deal looks like it will add to the deficit problem, it may raise credit concerns, which would also contribute to higher interest rates.

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A winter chill settles over the economy

January 2, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Late last month, the official estimate of economic growth for the fourth quarter was revised upward. Does this signal a strong finish for 2012 -- or simply set the economy up for yet another disappointment?

Unfortunately, new figures on retail sales suggest the latter might be the case. If so, it would mark the third time since the Great Recession that the U.S. economy has revved its engines, only to do little more than spin its wheels.

Economic data remains mixed

On December 20, the U.S. Bureau of Economic Analysis announced that real Gross Domestic Product (GDP) grew at a 3.1 percent rate in the third quarter of 2012. This marks a healthy increase over the previous estimate of 2.7 percent growth, and a considerable increase over the initial estimate of 2.0 percent. Since that first estimate was made in late October, this measurement of economic growth has transitioned from mediocre to very promising.

A 3.1 percent growth rate represents a significant improvement over the second quarter's growth rate of 1.3 percent, and would be easily the best quarter for economic growth so far in 2012. However, in recent years the economy has shown flashes of growth before without being able to follow through. The fourth quarters of both 2009 and 2011 had GDP growth rates in excess of 4 percent, only to see the next quarter's growth slow by about half.

In order to really put a dent in unemployment, economic growth needs to be sustained over a period of several quarters. Unfortunately, the U.S. economy hasn't been able to string together back-to-back quarters of 3 percent or better growth since 2007.

A new snapshot of retail spending suggests that the end of 2012 won't be any different. The MasterCard Advisors SpendingPulse estimate of holiday spending found that buying activity over the two months preceding Christmas was up only 0.7 percent over the prior year. This was the slowest growth rate for holiday spending since 2008, and represents a big disappointment against analyst estimates of 3-4 percent for this year.

The shadow of the cliff

Why did the economy suddenly put on the brakes in the fourth quarter? There are a few possible explanations, but a likely culprit seems to be concern over the fiscal cliff. The prospect of take-home pay suddenly dropping might not only have prompted consumers to be more conservative about holiday spending, but it also may have influenced businesses to rein in their expansion and hiring plans.

Outlook for savings accounts

Slow economic growth dampens the outlook for interest rates on savings accounts. These rates are already near zero, and are unlikely to rise unless sustained growth gives banks more incentive to attract deposits.

Based on the latest economic data, bank customers may expect no relief from low interest rates early in 2013. The only way to improve those rates at the moment is to actively shop for better rates, rather than waiting for rates to rise across the board.

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