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Personal Finance Blog By MoneyRates - June 2013

Inflation returns meekly, but still overpowers deposit rates

June 20, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Inflation returned to positive territory in May, but just barely. The continued quiet on the inflation front is good news for consumers -- and for the Federal Reserve.

Inflation's gentle return

The Bureau of Labor Statistics announced Tuesday that the Consumer Price Index (CPI) rose by just 0.1 percent in May. This was just the second rise in the CPI in the past seven months, and the 0.1 percent increase is consistent with the 1.4 percent total increase over the past 12 months.

This kind of mild inflation should be very comforting for the financial markets. Declining prices would indicate deflation and raise concerns that the economy is weakening. On the other hand, stronger inflation would be likely to push interest rates sharply higher, creating a stiff headwind for stocks, real estate and other asset prices. In contrast, a mild increase falls right between these two extremes, causing a minimum of disruption to the economy.

May's inflation figures even indicate an unusual degree of consistency across all sectors, so there seem to be no potential trouble spots developing for prices. Most notably, energy prices have moderated considerably, which is a key to keeping inflation on a steady course.

What the latest CPI number means

A mild inflation number is always worth a sigh of relief. It's not going to put anybody back to work, but at least fast-rising prices are one problem consumers don't have to worry about right now. Here are some other implications of the latest CPI release:

  1. Depositors lose -- again. Low inflation should be good for depositors, because it helps keep the purchasing power of their deposits intact, but current interest rates on savings accounts and other deposits are so low it really leaves no margin for inflation. With rates on savings accounts averaging 0.06 percent, even May's slight 0.1 percent rise in the CPI was enough to wipe out more than a year's worth of interest in a single month.
  2. The rise in mortgage rates may slow. Mortgage rates have been rising steadily for six weeks, on the strength of improved economic data and speculation about when the Federal Reserve will end its intervention to keep interest rates low. Evidence that inflation is remaining tame could take some of the urgency out of the rise in mortgage rates.
  3. It buys the Fed some time. Speaking of the Fed, a moderate inflation number is good news for them, because it means they can remain focused on nurturing economic growth. Higher inflation might have forced the Fed to cut back its stimulus sooner than planned, but so far inflation seems to be cooperating.

With inflation well under 2 percent annually, it leaves some room for prices to rise as the economy heats up, without getting out of control. The key for consumers -- and rates on savings accounts -- will be for that economic strength to come around before inflation starts to accelerate.

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Tepid job growth cools the outlook for deposits

June 13, 2013

| MoneyRates.com Senior Financial Analyst, CFA

As rates on savings accounts threaten to disappear into nothing, the latest jobs report did nothing to provide a boost.

The report on May job growth from the Bureau of Labor Statistics (BLS) was pretty much right down the middle -- not disappointing, but not a pleasant surprise either. That kind of mediocre showing is not likely to move interest rates higher, especially when it comes to rates on savings accounts and other deposits.

Mediocre employment growth

The BLS reported last week that a net total of 175,000 new jobs were created in May. That almost exactly matches the average of 172,000 new jobs that have been created monthly over the past year. In other words, May's job growth was about average by recent standards, though a little below average if you subtract the 12,000 jobs represented by downward revisions of previous months' employment estimates.

Between tepid job growth and growth in the labor force, the unemployment rate was virtually unchanged in the latest report, at 7.6 percent.

Economic implications

What does this job market information say about the economy? It places the economy in the same holding pattern it's been in for about four years now: growing, but not gaining any momentum. The soft job market is both a symptom and a cause of this problem. Employers lack the confidence in the economy to start hiring in big numbers. In turn, with people only slowly able to return to work, just a trickle of new wages are being introduced into the economy.

The other element that has influenced interest rates is the Federal Reserve's monetary stimulus. The Fed has stated that it will continue measures to keep interest rates down until unemployment falls to 6.5 percent. With unemployment treading water at 7.6 percent, the Fed looks as though it will keep downward pressure on rates for the next several months.

A double standard for interest rates

Along with mixed news on the economy, there has also been something of a double standard on how banks are setting their interest rates.

Mortgage rates were on the rise throughout May, suggesting that lenders saw enough improvement in the economy to expect higher interest rates in the future. At the same time though, CD, savings and money market rates remained unchanged.

The explanation is that while banks and other mortgage lenders are anticipating an eventual upturn in economic activity, they don't necessarily see it happening right away. So, when it comes to making 15- and 30-year loans, they are eager to protect themselves by raising rates. However, when it comes to offering higher rates on short-term deposits, banks simply don't see the need to do so just yet.

It will take more than a mediocre jobs report to push those deposit rates higher. In order for that to happen, monthly job growth will probably have to get to the 200,000 level -- and prove it can stay there.

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Weak manufacturing numbers: the latest setback for savers

June 6, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Earlier this week, a report on U.S. manufacturing activity in May from the Institute of Supply Management (ISM) put a damper on what has lately seemed to be an increasingly upbeat economy. This setback also cast doubt on when -- or whether -- savings accounts would benefit from the recent rise in bond market interest rates.

Manufacturing slowdown

According to the ISM, overall manufacturing activity in the United States contracted during the month of May, marking the first time that has happened since November 2012.

The ISM report had three troubling aspects. First, the reference to November 2012 is ominous, since that was the middle of a quarter in which real GDP growth slumped to a barely moving 0.4 percent. Second, the Manufacturing Index reading of 49.0 for May was the lowest since June 2009, when the economy was still struggling to emerge from the Great Recession. Third, this does not appear to be a case in which an isolated signal gives a false reading. May marked the third consecutive month in which the Manufacturing Index has declined from a year-over-year perspective.

Contraction in the Manufacturing Index does not necessarily mean contraction for the economy as a whole. According to the ISM, a Manufacturing Index level of 49.0 is consistent with real GDP growth of 2.1 percent. That would not represent a return to recession, but it would represent more of the sluggish, almost sleep-walking mode the economy has been stuck in for most of the last four years.

Interest rate reaction

Throughout virtually all of May, bond yields rose in reaction to growing optimism about the economy. In part, interest rates reflect how the price of capital is affected by the strength of the economy, with greater demand leading to higher interest rates. This tends to manifest itself first in the bond market, and later in more artificially set rates, such as those for mortgages and savings accounts.

During May, yields on 10-year Treasury bonds rose by nearly half a percentage point. Mortgage rates began to rise too, though average rates on savings accounts did not. The question is, if the rise in rates was based on economic optimism, what was the reaction to the disappointing manufacturing report?

The answer is that so far, that reaction has been fairly mild. Ten-year Treasury yields dropped by just 3 basis points the day the report came out, and stabilized the next day.

For the time being then, think of the rally for interest rates as being on hold. The rise in bond yields may pause, and the eventual response of savings accounts may be delayed, until clear evidence comes along to contradict the apparent slump in manufacturing. That may happen as soon as this Friday, with the May report on employment growth. However, if that report disappoints, expect bond yields to suffer a tumble -- and take with them the hope that savings account yields will rise in the near future.

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