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Personal Finance Blog By MoneyRates - August 2013

Middle East tensions menace a delicate economy

August 29, 2013

| MoneyRates.com Senior Financial Analyst, CFA

The next month will see several announcements that could signal key developments in the economic recovery, including a revised estimate of second-quarter GDP, an update on employment, August inflation numbers and the statement from the next Federal Open Market Committee meeting.

None of these, however, has the potential to be as disruptive to the economy as events taking place thousands of miles away in the Middle East.

Economic effects of conflict in the Middle East

The Middle East always seems to be the centerpiece of global turmoil, but lately tensions have been rising beyond their usual level. The alleged use of chemical weapons by the Syrian regime may prompt intervention by the United States and its allies. Already, the conflict has become something of a proxy war between hostile governments in the region. Now, it has the potential to draw in an even wider sphere of combatants.

Further raising the stakes is that Syria is home to Russia's only naval base outside of the territories of the former Soviet Union. For a country that has been concerned with naval power since the days of Peter the Great, this ready access to the Mediterranean is a high priority, so Russia has strongly supported the existing Syrian regime. So, perhaps more so than at any time since the end of the Cold War, the United States and Russia find each other on opposite sides of a military conflict.

Meanwhile, farther south and west along the Mediterranean coast, Egypt seems on the verge of a civil war. Given Egypt's military strength, its history as one of the more stable nations in the region, and its non-belligerence toward Israel over the past 30+ years, the potential for dramatic change in Egypt is unsettling to the entire region.

The most immediate economic danger posed by unrest in the Middle East is a rise in the price of oil, which could quickly spur broader inflation. According to the U.S. Energy Information Administration, the price of a barrel of oil was already up by more than $14 from the start of 2013 through August 26. Then, oil spiked by another $3.09 on August 27, as rhetoric concerning Syria heated up.

Implications for interest rates

Consumers could have a lot to lose if rising oil prices lead to inflation. Interest rates would be likely to rise, making mortgages more expensive and possibly snuffing out the recovery in home prices. Meanwhile, savings accounts could lose even more ground to rising inflation. Rates on savings accounts might finally rise, but most likely at a slower pace than surging prices, thus quickening the pace at which savings accounts are losing purchasing power.

There are human and strategic costs to consider in decisions concerning the conflicts in the Middle East. On top of that, the economic costs could have a widespread and long-lasting impact.

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Lackluster productivity threatens the outlook for deposits

August 22, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Last week the Bureau of Labor Statistics (BLS) announced that productivity had grown at an annual rate of 0.9 percent during the second quarter. An increase in productivity might sound good on the surface, but this report actually carried some sobering warning signs.

The second quarter's 0.9 percent annual rate of productivity growth is a fall-off from 2012's rate of 1.5 percent, and from the average of 2.1 percent over the last four calendar years.

What's even more disturbing is that in the latest BLS report, the estimated rate of productivity growth during the first quarter of this year was revised downward from a positive 0.5 percent to a negative 1.7 percent. This was the result of downward revisions in the original estimates of both output and hours worked, with the drop in the estimate of output being the greater of the two. The result is that output actually declined in the first quarter, suggesting that the economy is slowing and getting less efficient as a result.

The significance of productivity

Productivity is a measure of the economy's efficiency. It captures the amount of output a workforce creates per hour worked, so any time output grows faster than the amount of time worked, it means the economy is becoming more efficient. The real significance of productivity is that it has implications for both economic growth and inflation.

Productivity tends to grow when economic growth is accelerating. When demand increases, businesses are pushed to operate at closer to full capacity, and growth in output usually happens faster than increases to the workforce. These things result in strong productivity gains.

On the other hand, when productivity gains slow, it can be a sign that underlying demand has slowed unexpectedly, signaling trouble for economic growth. Looking back, a sudden drop in productivity in 2006 might have been a warning sign of the coming recession. Productivity gains averaged a very healthy 3.1 percent in the 10 years through 2005, but then dropped to 0.7 percent in 2006.

Productivity also has an influence on inflation trends. If output is rising faster than the hours worked, it indicates that efficiency is growing and this efficiency helps moderate price increases. Productivity growth can be a key to achieving strong economic growth without high inflation.

Implications for the economy and savings accounts

With productivity growth estimated at -1.7 percent for the first quarter and 0.9 percent for the first quarter, so far 2013 is on track for a net loss in productivity for the year. This could mean a bad year for growth, yet with some inflation pressure despite the weakening economy.

That environment is the worst of both worlds for savings accounts. Low growth means little hope of higher interest rates, while inflation means savings accounts would lose ground to rising prices at a faster rate. In sum, you can add productivity to the warning lights that have begun to flash recently on the economic dashboard.

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Inflation signals relax but not enough for depositors

August 20, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Recent weeks have been a worst-of-both-worlds scenario for savings accounts and other deposits, as stalled economic momentum weakened the prospect for rising interest rates, while a flare-up of inflation accelerated the loss of purchasing power in these accounts. But could conditions now be improving on at least one of those fronts?

A break from inflationary pressures

Concerns about inflation were calmed somewhat by the August 14 release of the Producer Price Index (PPI). In this report, the Bureau of Labor Statistics announced that the PPI was unchanged for the month of July, and had increased by 2.1 percent over the past 12 months. These numbers represent an easing of producer inflation compared to June's figures, when the PPI was up 0.8 percent for the month, and 2.5 percent for the past year.

Consumers are directly affected by retail prices, as reflected in the Consumer Price Index (CPI). However, producer prices can give some insight into the future direction of consumer prices. Companies tend to shelter consumers from short-term price changes for competitive and demand reasons, which is why the PPI can be more erratic from month-to-month than the CPI. In the end though, any sustained trends in producer prices will be reflected to some degree in consumer prices, as companies have to protect their profit margins.

For this reason, July's lack of change in the PPI is a welcome reversal of a trend that had seen producer prices rise sharply in both May and June.

Gasoline levels off

Significantly, easing energy costs were one reason that producer prices leveled off in July. Recent months have seen an increase in oil and gas prices that propelled a rise in overall consumer prices. Retail gas prices continued to rise in July, and this may well impact the CPI number for that month. Thinking longer-term though, it is encouraging to see producer energy costs easing, as these costs ultimately affect consumer prices in just about every sector.

Another good sign for the future is that retail gasoline prices actually slipped a little in the first two weeks of August. Gasoline prices rose sharply earlier this year and created some inflationary pressure, but now they are actually below where they were a year ago.

Implications for savings accounts

CD, savings and money market rates would benefit from two things: an improving economy and low inflation. An improving economy would improve the investment and lending outlook to the point where banks would feel a stronger incentive to attract deposits by offering higher interest rates. Until this happens, it is especially important for inflation to stay in check.

As it is, savings accounts and other deposits have already been losing purchasing power to inflation over the past few years. It may be too soon to expect deposit rates to get back ahead of inflation, but it is reasonable for depositors to hope that inflation doesn't rise even higher above the current levels of savings account, money market account and CD rates.

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Jobs letdown threatens to halt rising rates

August 8, 2013

| MoneyRates.com Senior Financial Analyst, CFA

The first six months of 2013 represented the best half-year for job creation since 2006. But last Friday's jobs report cast doubt on whether the economy can build on this momentum.

The Bureau of Labor Statistics announced that 162,000 new jobs were created in June, the lowest total since March. To add insult to injury, previously released figures for May and June were revised downwards by a total of 26,000 jobs.

Until those downward revisions, the job creation numbers for the second quarter had been 199,000 for April, and 195,000 for each of May and June. The hope was that the employment market could build upon this consistency and start to post in excess of 200,000 new jobs per month. Instead, the figure of 162,000 new jobs was a letdown. If job creation continues at that pace for the second half of the year, it would be the worst half-year since the second half of 2010.

This loss of momentum could slow the upward progress of interest rates. This is good news for consumers looking for mortgages, but bad news for people with money in savings accounts and other deposit vehicles.

Impact on mortgage rates

About a month ago, an encouraging report on June's employment was released on July 5. Not coincidentally, the week that followed saw 30-year mortgage rates hit their peak for the year at 4.51 percent. They've since slipped back, as the outlook for the economy has begun to appear more clouded.

At under 4.5 percent, current mortgage rates may be higher than they were a few months ago, but they are still much lower than they've been throughout most of their history. They should be low enough to remain attractive to new home buyers, and if there are any more setbacks for the economy, some current homeowners may even get another shot at refinancing.

Impact on savings accounts

On the opposite side of the fence, depositors in savings accounts and other interest-bearing bank offerings would welcome a rise in interest rates.

While mortgage rates were quick to respond to economic developments by rising, deposit rates have been much slower to react. Since deposit rates represent a cost to banks, they are apt to be slower to raise them. From a bank's perspective, there is little reason to anticipate economic events by raising deposit rates. Instead, they are most likely to sit back and wait until the lending environment becomes so compelling that they have an incentive to attract more deposits. With the recent setback in job growth, that wait may have just gotten a little longer.

Watching for inflation

The next key development for interest rates may be the report on July's inflation, due out on August 15. If inflation shows signs of gathering steam, it could force interest rates higher. But it's a losing proposition for both mortgage and savings account customers when higher interest rates come alongside higher prices.

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Mixed economic signals leave savers in limbo

August 1, 2013

| MoneyRates.com Senior Financial Analyst, CFA

Mixed messages have been the norm for economic news in 2013, and this week has been no different. Good news on housing prices was offset by a lukewarm report on economic growth, leaving rates on savings accounts and other deposits stuck in their low-level limbo.

First the good news …

The good news this week was that the housing market continues to recover. The S&P/Case-Shiller Home Price Indices rose yet again in May, with their 10- and 20-city composites posting their best 12-month gains in more than seven years.

A strong housing market is generally associated with a healthy economy, but even these encouraging home price figures have to be viewed with some reservation. The latest S&P/Case-Shiller figures represent a three-month average ending in May, so they would have been only slightly affected by the rising mortgage rate trend that began in May.

The housing market can thrive despite rising mortgage rates if economic growth is strong enough, but that was called into question by the latest reading on U.S. gross domestic product.

... now the not-so-good

Yesterday the Bureau of Economic Analysis (BEA) released its advance estimate of GDP for the second quarter. At 1.7 percent, the economy's real rate of growth in the second quarter was not exactly robust. Indeed, you can think of GDP growth rates roughly along the lines of college grades, where a 4.0 or better would be an A. On that scale, 1.7 percent represents a C minus.

An optimist could point to the fact that the second quarter's 1.7 percent is an improvement over the 1.1 percent growth rate in the first quarter. However, even that improvement is something of a disappointment, because the first quarter's rate has been revised downward three times now. At the end of April, the BEA issued its advance estimate of first-quarter GDP growth at 2.5 percent. This was subsequently revised downward to 2.4 percent, then to 1.8 percent, and most recently to 1.1 percent -- not a very encouraging trend.

Outlook for savings accounts

Any significant improvement in CD, savings and money market rates is likely to come toward the end of a long chain of events that starts with sustainable economic improvement. Only when that occurs will banks have the confidence to increase lending activity; only when loan volume increases sufficiently will banks have an incentive to attract more deposits; only when that incentive is established are meaningful increases in bank rates likely to occur. With signs on economic growth still mixed, the journey toward higher deposit rates has yet to complete its first step.

Alternatively, interest rates could be forced up more quickly if inflation gathers momentum. However, this would not represent a win for consumers, as savings accounts would be struggling to play catch-up with rising prices.

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