Saturday, April 25, 2009

Fed measures killed the yield on household saving

A reader of this blog expressed concern about the effects of the Fed's massive expansionary efforts on the value of household saving. Specifically, the Fed slashed its fed funds target 510 bps from 5.25% in September 2007 to 0%-0.25% in December 2008, which has likewise driven down saving yields. Tom Petruno at the LA Times wrote a piece to this effect:
Who's really bailing out the banks?

Taxpayers, for sure. But the largely unsung victims of the financial system rescue are loyal bank depositors -- especially older people who have relied on interest income from savings certificates to live.


To save the banks from soaring loan losses, the Federal Reserve did what it always does when the industry gets into trouble: Policymakers hacked their benchmark short-term interest rate, which in turn pulled down all other short-term rates, including on savings vehicles.


But this time the Fed went to rock-bottom on rates. In December, the central bank declared that it would allow its benchmark rate to fall as low as zero.


Savers still are paying the price for that gift to the banks. Average rates on certificates of deposit nationwide have continued to slide this year, according to rate tracker
Informa Research Services in Calabasas.

The average yield on a six-month CD fell to 1.27% this week, down from 1.86% on Jan. 1 and 2.24% a year ago. Anyone who has a CD maturing soon should be prepared for serious sticker shock.


Banks have been able to continue whittling down savings yields because the industry overall is flush with cash -- not just from the Fed's efforts to pump unprecedented sums into the financial system, but also because the events of the last year have left many people too afraid to keep their money in anything but a federally insured bank account. At least you know your principal is guaranteed.


Even as short-term interest rates have dived since the financial crisis exploded in September, the total sum in
CDs under $100,000, as well as savings deposits and checking accounts, has soared by $507 billion, to $6.07 trillion, according to data compiled by the Fed.
RW: In spite of the rock bottom rates on saving accounts, CDs, and money market mutual funds, households continue to flock to the safety of these insured funds. And in response to increasing demand for saving instruments - the personal saving rate rose from 0.3% in February 2008 to 4.2% one year later - banks will draw down yields further.

Buy what Tom doesn't' say is that rock-bottom rates are here to stay. According to the FOMC statement:
"economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."
And how long is that? Well, recently the Bank of Canada, whose interest rate policy tends to move in sync with the Fed's, released its monetary policy statmement. The BoC cut its overnight rate target to 0.25%; but more importantly, it made a definitive statement of how long might be an extended period:
"Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target."
It looks like saving rates will be low for a while, folks. The massive economic contraction is dragging down prices, and the IMF is forecasting U.S. deflation throughout 2010 (see Table A5 in the World Economic Update). Using the BoC's statement as a proxy for extended period, the near-zero federal funds target will hold saving yields low until June 2010, fourteen more months from now.

Disclaimer: To me, deflation remains to be a mechanism to clear markets rather than a macroeconomic hindrance. And furthermore, the IMF's outlook is very gloomy. Clearly, with 0% growth in 2010 for both the U.S. and the sum of advanced economies, the IMF expects an onslaught of defaults that are already in the pipeline, defaults that are not currently priced into market activity. We will see, though. The World Bank is projecting 2% U.S. growth in 2010.

Rebecca Wilder

3 comments:

  1. "It looks like saving rates will be low for a while, folks."

    I hate to be the person always sounding paradoxical, but the response from people that we want is to for them to find the low rates unacceptable and to start to go looking for riskier and higher yielding investments. That's how you conquer the fear and aversion to risk.

    The added risk is, in fact, investment in forward looking projects that are unusually scary in a downturn. Presumably, that's the rationale for government investing during a downturn. Those of us who like private investment better than government would prefer individuals to start accepting more risk in investment.

    Since many businesses don't make it, investing under our system is always risky. That's why we need risk. I'm not an investor, but I'd look into corporate bonds.

    Don the libertarian Democrat

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  2. Don:
    Good comments, and you're absolutely right. 'We' leave it to the Gov to take over risk management in these kinds of times, but of course, as much as the Gov has a role to play, 'picking favourites' (pardon the Cdn spelling) is one of their poorer ones, pun not intended but apt.

    I've been searching for a definitive term for 'Quantitative Easing' but it is as elusive as Sasquatch.

    The best definition I've come across states that there is no definition, and the term leads to much misunderstanding.

    It has often crossed my mind that as problematic as the device is, it would help out savers if it were used instead of dropping rates to near zero or zero.

    I'm trying to catch-up on my reading today, been a busy few last days, and dammit, it's Saturday morning and my reading of the Bank of Canada Monetary Report is hazy and devoid of meaning, as primarily I was after their purported reference to 'Quantitative Easing'....

    So what do I find in yesterday's Globe and Mail Editorial?

    An excellent overview that saves me having to chew breakfast today:
    [April 24, 2009

    The Bank of Canada's monetary policy report yesterday prudently held the possibility of quantitative easing in reserve. To influence credit conditions, the bank has increasingly relied, over the past four decades, on interest rates. But its present "policy" rate is effectively at its lower limit, and if borrowing and lending conditions become tighter, the bank will probably need to create credit, going beyond policies that affect the price of credit.

    The bank's report correctly observes in a footnote that, though quantitative easing is often called an unconventional measure, it is the conventional approach as laid down in economics textbooks. The upshot is that, while those who have studied introductory economics know about quantitative easing, central bankers in Canada and other countries no longer have much practical experience of it. That is one of the reasons for proceeding with caution.

    Another major reason for prudence on this front is the danger of inflation, and even of 1970s-style stagflation, that is, the combination of slow growth (or none) with inflation. But increases in the supply of credit are in principle perfectly compatible with inflation targeting of the kind that has been adhered to for decades.

    Central-bank credit creation typically consists of purchases of government treasury bills or bonds, of which there is hardly likely to be any shortage in this time of deficit finance.

    The similar but alternative approach known as "credit easing" would consist of purchases of private-sector securities, which does not necessarily create new money, but has the disadvantage of the appearance - or even the fact - of favouring specific private interests.

    Although the Bank of Canada's report is about monetary policy, it contained much about the economy as a whole. Some of this has already been interpreted as criticism of the Obama administration, and in particular, Timothy Geithner, the Secretary of the Treasury. But the delay in repairing the U.S. financial system can be fairly attributed to both the previous and the past administration, in their series of improvisations.

    Perhaps the Bank of Canada underestimates the slowness of political action, which is a reality in Canada as well as the U.S. The infrastructure spending in the fiscal stimulus package has not yet taken effect; the interval between budgeting and "shovels in the ground" continues.

    Fortunately, however, the bank has clearly articulated its policies on the actions it can take itself, ranging from interest rates to credit creation.]
    http://www.theglobeandmail.com/servlet/story/LAC.20090424.EBANK24ART1951/TPStory/Comment

    There is a grammatical error: Read "present and past" for "previous and past administrations". I glossed over it a few times before realizing it, inconsequential as it is.

    News reports were alluding to the BoC's adoption of QE as a foregone conclusion.

    Not so, evidently, and there's a news report that in fact, even a month left to go before the fiscal budget, the Feds are most likely able to avoid a deficit. (Rebecca commented on this some weeks back. Deficit or not, the fiscal malaise is light compared to any other G7 or most any other industrialized nation.

    That of course, plays into the conundrum of how much stimulus is enough? Canada is claiming 3% of GDP, but of course, that involves sleight of hand, just as the Deficit or Not does.

    Whatever, hats off to Rebecca for yet again using Canada as a vector point to see how far into the marsh the US has gone.

    Sasquatch may yet be found.

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  3. Wasn't "interest on reserves" supposed to partially counteract, or absolutely control, low interest rates, especially for savers?

    Oh, maybe it was the elimination of REG Q ceilings!

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