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Personal Finance Blog By MoneyRates - April 2013

The yin and yang economy

April 25, 2013

| MoneyRates.com Senior Financial Analyst, CFA

The price of a barrel of oil recently dipped below $90, which on the surface seems like good news for consumers and depositors in savings accounts. However, the context of the slide in oil prices is yet another example of the yin and yang nature of today's U.S. economy.

Just as yin and yang represent the good and the dark sides of life, the decline in oil prices over the past couple weeks has a kind of positive and negative duality. Cheaper oil prices are welcomed by most Americans, but what they say about the strength of the economy is troubling.

The dip in oil prices

Oil has had an up-and-down year so far in 2013. On a few occasions, the price of a barrel of oil has peaked at just over $97, only to slip back. Oil was up to that level again as recently as the first couple days of April, but by April 22 the price had fallen to $88.76, a low point for the year and a drop of about 9 percent.

Nobody who drives a car has to be told why lower oil prices are good news. Even away from the gasoline pump, lower oil prices benefit consumers in general because oil tends to set the tone for inflation in general. In particular, lower inflation -- or even a roll-back in prices -- would be a relief to people with savings accounts and other deposits, who have seen their purchasing power steadily eroded in recent years as bank rates have failed to keep up with inflation.

Broader context

The broader context for the decline in oil prices reveals the dark side of this news: Oil prices tend to fall when the economy is weakening, and economic news lately has been full of signs of weakness.

The latest example was the release of existing home sales figures on April 22. The National Association of Realtors (NAR) announced that completed sales of single-family homes declined by 0.6 percent in March. A recovery in real estate had been one of the economy's few consistent bright spots over the past year, so a cooling off in home sales is reason for pause. While the NAR dismissed the lower sales figure as being due to inventory constraints, the fact that the total inventory and the length of housing supply both increased in March suggests the drop-off may be due to weakening demand.

The bottom line for savings accounts

With the decline in oil prices representing both inflation relief and economic weakness, what's the bottom line for savings accounts?

Depositors might think of falling oil prices as the type of relief that addresses a symptom without curing the disease. In an era of low interest rates, keeping inflation down limits the damage done to the purchasing power of savings accounts. However, the real cure for depositors would be a return of interest rates to a more normal level, and that isn't likely to happen until the economy strengthens.

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A drop in consumer prices -- with a catch

April 18, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Inflation took a step back in March, which is news that should come as a relief to bank depositors in savings accounts and other interest-bearing instruments. However, there is a catch involved that prevents this from being completely good news for depositors.

Prices decline in March

On April 16, the Bureau of Labor Statistics announced that the Consumer Price Index (CPI) declined by 0.2 percent in March. This put to rest fears of a flare-up of inflation that had been stoked by the previous inflation report, which showed a 0.7 percent rise in the CPI during February. The decline in consumer prices during March left inflation at a moderate 1.5 percent over the past year, and running at an even milder pace over the past six months.

Once again, petroleum products were the key driver of inflation. In February, a 9.1 percent spike in gasoline prices had contributed heavily to the rise in the CPI. In March, a 4.4 percent drop in gasoline prices was the leading factor the CPI's decline.

Declining prices are a welcome break for bank depositors. With CD, savings, and money market rates generally running below 1 percent, virtually any inflation represents a loss of purchasing power for bank accounts. The catch is that the March decline in CPI was accompanied by signs of a slowing economy, and that is not good news for depositors.

Four scenarios and their impact on savings accounts

To better understand the trade off between falling prices and slowing growth, imagine a four-way grid that depicts the possible outcomes for both inflation and economic growth, with each ranging from high to low. The result would be four possible combinations, as described below:

  1. Low inflation, slow growth. If this sounds familiar, it's because it has been the dominant environment of the past few years. In this scenario, inflation doesn't do too much damage, but savings accounts are not able to get ahead because slow growth keeps interest rates low.
  2. High inflation, slow growth. This would be even worse for depositors, because while rising inflation might eventually push interest rates higher, a slow growth environment would likely mean that interest rates would rise more slowly than inflation, causing savings accounts to lose purchasing power more quickly.
  3. High inflation, high growth. Under this scenario, both interest rates and prices could rise rapidly. Savings, money market and certificate of deposit rates would look healthier, but that would largely be an illusion because much of those higher rates would be eaten up by inflation.
  4. Low inflation, high growth. This was the best-of-both-worlds environment that the U.S. enjoyed during the late 1990s. It would give interest rates a chance to get solidly ahead of inflation again.

The March CPI number suggests the U.S. is still in the first scenario. Depositors can count their blessings that it isn't the second one, but the ideal of the fourth one still seems a long way away.

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Job growth slowdown equals disappointment for savers

April 11, 2013

| MoneyRates.com Senior Financial Analyst, CFA

It was more bad news for the economy last week, as the employment report for March announced that a disappointing total of just 88,000 new jobs were created during the month. This follows the creation of 268,000 jobs in February, and suggests that the employment market is still as uncertain as ever.

To continue a long-running theme, what's bad for the economy is also bad for savings accounts and other deposits. Low interest rates are closely tied to the chronic weakness in the economy, both for fundamental reasons and because of the Federal Reserve's monetary policy. The latest setback suggests it will be an even longer wait for higher CD, savings and money market rates.

A sharp fall-off in job growth revives lingering questions

The Bureau of Labor Statistics (BLS) reported that 88,000 new jobs were created in March, a figure well below expectations, and a sharp fall-off from February's figure. There was little consolation in the fact that both January and February's estimates were revised upward. While that means that there are more people employed than previously thought, a big part of what matters here is the trend, and the March report disappointed any belief that the trend in the job market might be turning up.

Not only was job creation in March below January and February's numbers, but it was barely half the monthly average of 169,000 new jobs that had been created over the past year.

This slowdown in job creation reiterated lingering questions about what impact government austerity measures are having on the economy. A round of tax increases at the beginning of the year followed by the forced spending cuts of sequestration mean that the federal government has now created two drags on growth. Add to that the uncertainty created by the ongoing budget standoff, and many will trace the recent fall-off in job creation directly to Washington.

A sign of hope?

Amid all the bad news for jobs, there was one potential good sign. In a separate report, the BLS announced that there were about 314,000 more new job openings at the end of February than at the end of January. Job openings at the end of February were also nearly 400,000 higher than they had been a year before.

Although there may be a number of structural reasons why these jobs aren't being filled, the growth in openings creates hope that the disappointing jobs figure for March was simply a question of timing rather than a real slowdown in hiring.

The reaction of interest rates

Interest rates did not react as if they saw any silver lining in the jobs report. While very short-term rates held level because they are already within a few basis points of zero, Treasury bond rates across most of the yield curve, from three months to 30 years, declined in the first week of April.

This suggests that bank rates can be expected to remain low until the job market starts sending more encouraging signals.

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Former US budget director predicts economic doom

April 3, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Former Reagan Administration Budget Director David Stockman created a stir this week while promoting his new book, which predicts the U.S. economy is headed for a hard fall -- largely because of its fiscal and monetary policies.

These words of warning, which Stockman details in "The Great Deformation: The Corruption of Capitalism in America," come in direct contrast to the growing mood of optimism on Wall Street. Several financial commentators sharply criticized Stockman for his "Chicken Little" predictions. Prophets of doom are never particularly popular when the market's still making money, though that's when words of caution can be most useful. Here is a review of some of Stockman's concerns:

  1. Deficit spending is unsustainable. Economist Paul Krugman has taken Stockman to task for complaining about deficits, since Stockman oversaw huge deficit increases as Reagan's budget director. Still, Stockman is entitled to change his mind about deficits, and more to the point, the wisdom of deficit spending is really a matter of circumstances. Modest deficits to goose a sluggish economy can be useful. What every President except Clinton has failed to do in the last 40 years is bring the budget back into surplus during economic expansions. As a result, deficits have gotten steadily larger over time, and the accumulated debt total has continued to build.
  2. A "warfare state" is being built on top of a welfare state. One criticism of social programs is that they create continuing obligations which become increasingly hard to meet, and military spending takes on a similar momentum. The wars in Afghanistan and Iraq were instrumental in setting the latest cycle of deficit increases in motion, and with potential nuclear threats from Iran and North Korea, it will be hard to cut back on defense now -- unless more people start to view the deficit itself as a national defense concern.
  3. Fed policies have created an asset bubble. By lowering interest rates on everything from savings accounts to long bonds, the Fed has created an investment climate in which stocks seem like the only worthwhile game in town. With CD, savings, and money market rates losing ground to inflation, investors are more likely to turn to riskier alternatives in search of higher returns. As a result, stock prices have soared, but could the market sustain these levels without low interest rates? Until the Fed's stimulative policies generate enough earnings growth to support today's stock valuations, the fast-rising market will look more and more like a bubble.

Stockman's concerns are valid, but his predicted outcomes don't necessarily have to come true. If the private sector of the economy finally gets moving, and if the government takes advantage of that stronger economy to backtrack to more conservative fiscal and monetary policies, then the stimulative measures of high deficits and low interest rates may pay off. Still, Stockman's words serve as a warning for what could happen if all those "ifs" don't fall into place.

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