Personal Finance Blog By MoneyRates - July 2013
July 25, 2013
When Detroit declared bankruptcy last week, the financial markets took the news more or less in stride. However, this could become yet another factor affecting interest rates on savings accounts, mortgages and other bank products.
Detroit is the largest American city to file for municipal bankruptcy. It has just over 700,000 residents, and its financial liabilities could reach $20 billion. At a staggering $28,500 in liabilities per resident, that presents a compelling reason why the city declared bankruptcy.
Indeed, Detroit's condition has been so bad for so long that perhaps the muted response from the financial markets can be chalked up to a sense of inevitability. Still, while this bankruptcy may not have been a huge surprise, it does raise a number of questions whose answers are as yet unknown:
- Who's next? Detroit is far from the only U.S. local government in deep financial trouble -- even some states face unmanageable pension obligations. Mayors, governors and other officials around the country are going to be watching the Detroit bankruptcy carefully, and if it turns out to be a fairly painless way of hitting the reset button, expect a series of other governments to start showing up in bankruptcy court.
- How far does Detroit want to go? Bankruptcy does not have to be drastic. Sometimes, a slight reorganization of obligations can structure them in a more manageable way. If, on the other hand, Detroit looks at this as an opportunity to wipe much of the slate clean, expect it to have a much more disruptive impact on the pension system and on lenders -- if, of course, the bankruptcy judge goes along.
- How do Detroit's creditors make up their losses? The lenders and bond holders to whom Detroit owes money have their own obligations to meet. If they are caught seriously short by Detroit's bankruptcy, then there could be a ripple effect of other defaults.
- What are pensioners going to do? While private employees have largely been set adrift on the uncertain waters of defined contribution plans over the past three decades, public employees have enjoyed the certainty of defined benefit plans. Detroit's bankruptcy could undermine that certainty, and add to America's already troubling retirement crisis.
- Will lenders become more reluctant? As it stands now, banks already have very low ratios of loans to deposits, meaning they have little incentive to attract more deposits. If high-profile loan defaults make banks even more skittish about lending, it could result in a worst-of-both-worlds scenario for consumers, where loan rates go up while rates on savings and money market accounts and stay near zero.
From Wall Street to the European Union, the domino effect when one of a series of interdependent entities gets in financial trouble has been painfully evident in recent years. With its bankruptcy announcement, Detroit becomes the latest domino to wobble. How far it tips over and how many other dominoes it takes with it will be an important story in the second half of 2013.
July 18, 2013
For the past couple of months, the narrative describing the outlook for interest rates has centered around economic growth and the Federal Reserve's reaction to that growth. Now inflation has added a new and potentially ugly twist to that narrative.
Anticipated growth drives a turn in interest rates
Since the end of April, some interest rates have been rising on signs of economic growth. Most notably, job creation has picked up steam -- the first half of 2013 was the best calendar half for job growth since 2005.
Accelerating growth generally can make interest rates rise, and this is especially true now because the Federal Reserve has held interest rates down to stimulate growth. As that growth finally comes through, it is anticipated that the Fed will start to ease its stimulus. While Fed Chairman Ben Bernanke has recently sought to soothe nervous investors by reassuring them that the Fed won't ease short-term rates until growth is more firmly established, longer-term rates will rise naturally as the Fed eases its asset buying programs.
Inflation may force Bernanke's hand
The new twist came Tuesday when the Bureau of Labor Statistics reported that inflation rose by 0.5 percent in June. That may not sound like much, but it translates to an annual rate of more than 6 percent.
If markets were nervous about rising interest rates before, they may be even more jittery following this inflation report. Inflation not only drives interest rates higher on its own, but it could also force the Fed to be more aggressive about raising interest rates in order to prevent price increases from getting out of hand.
So far, this flare-up of inflation is just a single-month event, and short-lived inflation blips are not uncommon. However, energy costs were the driving force behind June's higher inflation number, and there hasn't yet been any sign of oil prices easing.
Consumers get bitten on both sides
As it stands now, consumers are getting bitten on both sides -- as savers and as borrowers.
As savers, consumers are stuck with rates on savings accounts, money market accounts and CDs that are near zero. Even with moderate inflation, savings accounts were losing purchasing power, and those losses will accelerate if inflation picks up faster than bank rates rise. So far, that race is simply no contest.
On the borrowing side, consumers are already facing higher mortgage rates. Banks have been quick to raise mortgage rates so they don't get caught short as interest rates rise, and they will be even more aggressive about raising those rates if there is a whiff of inflation in the air.
Looking forward, if interest rates are pushed higher by continued improvement in the economy, that will mean they are being driven by demand, and there are certainly some benefits to that for consumers. However, if rates are pushed higher by inflation, that means they are being driven by fear, and that's not a good situation for consumers.
July 12, 2013
Mortgage rates resumed their upward march this week, jumping nearly a quarter of a percentage point in the wake of an encouraging jobs report from the Bureau of Labor Statistics.
While the continued climb in mortgage rates isn't great news for home buyers, the rise in rates suggests optimism in the economy may be growing -- a trend that could eventually benefit depositors.
Pressure from the job market
At 4.51 percent, current mortgage rates are more than a full percentage point higher than they were two months ago. This is largely because optimism about the economy is growing, a factor whose influence could increase because a stronger economy would mean an end to Fed intervention to keep interest rates low.
The latest sign of improved economic strength came in the form of the Employment Situation Report for June, which was released last Friday by the BLS. This report showed that 195,000 jobs were created in June, an improvement over the average of 182,000 per month that were created throughout the previous year. In addition, there were large increases to the job creation estimates for the prior two months: An additional 50,000 jobs were added to April's number, and 20,000 to May's.
These job creation statistics are especially significant given the still-delicate state of the economic recovery. They not only show growing confidence from employers, but they also represent the creation of new weekly paychecks that will add fuel to the economy.
The employment report was especially reassuring because it came on the heels of a disappointing downward revision of the estimate of real GDP growth for the first quarter. That revision saw the estimate of real GDP drop from 2.4 percent to 1.8 percent. However, by now the first quarter is rapidly receding in the rear-view mirror. The jobs data from June is not only more encouraging, but it is also a more recent indication of the state of the recovery.
The advance estimate of second quarter GDP won't be available until July 31. In the meantime, many public companies will be announcing their earnings results for the second quarter. The strength of those results will provide some clues on the strength of the economy in the second quarter, and to the confidence corporations will have about hiring going into the second half of the year.
No help yet for savings accounts
Despite the recent increases in bond yields and mortgage rates, there is still no sign of widespread increases in rates for savings accounts and other deposits. There are two reasons for this. One is that bonds and mortgages are longer-term commitments than savings accounts, and thus must anticipate the future to a greater degree. The second reason is that mortgage rates represent income to banks, while interest on savings accounts represents a cost. Out of self interest, banks are likely to be quicker to raise mortgage rates than savings account rates.
Even given those factors, if the economy continues to strengthen, it will only be a matter of time before rates on savings accounts are headed higher as well.
July 5, 2013
In the words of an old song by The Kinks: Where have all the good times gone?
A month ago, the economy seemed on track for the ideal growth-with-low-inflation goal. Today, both components of that ideal seem to be in jeopardy.
A setback for growth
Every calendar quarter, the Bureau of Economic Analysis (BEA) makes three estimates of U.S. Gross Domestic Product (GDP) for the prior quarter: an advance estimate, a second estimate and a third estimate.
The advance estimate of real GDP for the first quarter was 2.5 percent. That's not a robust rate of growth, but as an improvement over the 0.4 percent rate for the last quarter of 2012, it was a strong move in the right direction.
The second estimate contained only a slight revision, down to 2.4 percent. However, when the third estimate came out last week, real GDP growth for the first quarter was revised all the way down to 1.8 percent. This is still an improvement over the prior quarter, but indicates progress at a much more sluggish rate. Especially given the start-and-stop nature of the recovery since the Great Recession, this tepid growth rate suggests the economy may be stuck in the same rut.
The threat of inflation
Inflation has been nicely under control in recent months. As of the end of May, the Consumer Price Index (CPI) had risen only 1.4 percent for the prior 12 months, and had registered just two monthly increases in the past seven months.
A key to this has been stable energy prices. Time and time again, oil in particular has proven to be a catalyst for broader inflationary trends. As of the end of May, a barrel of oil was selling for $91.97, and hadn't been above $100 in over a year. That has now changed. Oil began rising in June, and then climbed more steeply in early July to cross the $100 mark by the second day of the month.
This trend in oil prices may be too recent to have much of an impact on the CPI numbers for June that will be released in mid-July. But watch for inflation to perk up in the next couple months if oil prices don't start to subside.
The impact on savings accounts
The type of growth-with-low-inflation environment that the U.S. economy achieved in the second half of the 1990s is considered ideal for both businesses and consumers, and it also plays well for savings accounts and other deposits. Stronger growth would eventually push short-term rates to follow long-term rates higher, so CD, savings and money market rates would start to rise. At the same time, keeping a lid on inflation would allow those interest rates to get ahead of rising prices.
The sudden reversal into a state of disappointing growth and threatening inflation probably won't be the last twist in this convoluted economic recovery. For the time being though, it is enough to count as a setback for savings accounts.
July 2, 2013
Last Tuesday the stock market responded favorably to the latest S&P/Case-Shiller Home Price release, which showed a continuing rally in housing prices. But given the recent trend in interest rates, even this new report may be old news.
The housing release showed a record increase for April, and double-digit gains for housing prices over the past year. Unfortunately, as mortgage rates move higher, it creates a different set of conditions than those faced during that rally in home prices.
Right now, the economy is like a mystery, and reviewing emerging economic indicators is like sifting through clues. Some clues answer questions, while others merely provide hints. As enthusiastic as the stock market and the media were about the latest housing data, this information isn't really current enough to answer any questions -- and there are certainly plenty of questions.
Here are some of the key questions about interest rates that remain to be answered:
- What impact will higher mortgage rates have on home prices? The Case-Shiller Home Price Index is based on three months worth of data, with the June 25 release comprising data from February, March and April. Current mortgage rates are significantly higher than they were then, so the housing prices being reported now still don't reveal anything about what impact higher mortgage rates will have.
- Will higher rates also act as a drag on the economy at large? It's easy for any homeowner to understand how higher mortgage rates could slow down the housing market, and higher interest rates in general can have a similar effect on many aspects of economic activity. Employment growth remains the key: If new jobs continue to come into the economy at a reasonable pace, it will indicate that employers are undeterred by higher interest rates, and that more paychecks will be joining the consumer market.
- Will mortgage rates follow bond yields by continuing into higher territory? After a sustained rise, mortgage rates eased back in mid-June, while Treasury bond yields continued to rise. If mortgage rates stop rising soon, the effect on housing should be muted, but if they follow the course that Treasury bonds are leading, it will become tougher and tougher for the rally in home prices to continue.
- When will savings accounts see higher rates? Current mortgage rates have already risen enough to affect consumers, but depositors in CDs, money market and savings accounts have yet to see higher rates. Savings accounts and other deposits will probably be the last area to respond to higher interest rates, so when you see banks raise deposit rates, you'll know that the trend toward higher rates has been firmly established.
Some of these questions will take months to be answered, but this Friday's release of the June employment report will at least provide an update on how the economic recovery is surviving the rise in interest rates.