Fed needs you to take risks despite chaos
Fear of losing money has dominated investors’ emotions in the new year, which has translated into wrecked stock markets worldwide.
Odd as it may sound, what the Federal Reserve needs to do is restore the flip-side emotion: fear of not making enough money.
To put it another way, it would help the Fed, and the economy, if you took more risk with your nest egg. Ditto for the institutional investors who control the really big bucks.
The Fed’s dramatic three-quarter-point cut in short-term interest rates this week could be followed by another cut of at least half a point Wednesday, when the central bank wraps up its regularly scheduled January meeting.
Say goodbye to those low- or no-risk, mid-single-digit returns on bank savings certificates and money market mutual funds. We’re heading for yields that will make many conservative savers weep.
The annualized yield on the average money market mutual fund dropped to 3.78% this week from just under 4% the previous week, according to the Money Fund Report newsletter.
If the Fed takes its benchmark rate to 3% next week, as expected, money fund average yields will be in the mid-2% range within six weeks, says Connie Bugbee, who edits the newsletter.
Countrywide Bank, the deposit-taking arm of struggling mortgage giant Countrywide Financial Corp., was paying 5.45% on a six-month savings certificate at the start of the year. Now it’s offering 4%.
The official reason for Fed interest rate cuts, of course, is to ease the financial burden on borrowers and banks and make it easier for credit to flow, with the hope of bolstering economic activity -- or at least keeping the economy from spiraling into a deep downturn.
But a sharp drop in short-term interest rates has another effect. It ravages returns on low- or no-risk cash accounts and thereby forces investors to question just how safe they can afford to play it with their money.
You’ve probably got long-term goals for your nest egg, and chances are you won’t reach those goals earning 2% a year.
Nor, for that matter, would major pension funds and other institutional investors be able to meet their obligations earning low-single-digit returns, which is all that most Treasury securities pay now.
If that drives people out of cash and into the stock market, lifting share prices, it can bolster the economy by providing a psychological boost for investors in general and businesses in particular. After all, chief executives naturally are going to feel more confident about hiring and spending if the market is up than if it’s plummeting.
So far, however, fear still rules the markets. Cash returns may be paltry but they don’t look so bad compared with the 9.4% drop in the Standard & Poor’s 500 stock index year to date.
The mountain of cash in money market mutual funds grew again this week, reaching a record high of $3.21 trillion by Tuesday, Money Fund Report data show. Since the start of the year, investors have pumped a net $122 billion into money funds.
By contrast, dollars have been flowing out of stock mutual funds at a brisk pace this year -- including foreign stock funds, which had been many Americans’ favorite investments for the last few years.
As share prices crumbled around the world, a record $28.7 billion was pulled from foreign stock funds in the seven days through Wednesday, according to data tracker EPFR Global.
With the S&P; 500 down 15% from its record high in October, and some market sectors down much more, there are plenty of Wall Street pros who believe that stocks already are cheap and investors ought to step up.
“You’ve got to get in during chaos, because that’s when the opportunities arise,” says Marc Pado, U.S. market strategist at brokerage Cantor Fitzgerald.
But what many investors probably fear is that the chaos has just begun. When a rogue trader at a global bank can lose $7 billion on wrong-way market bets in a matter of weeks -- as France’s Societe Generale disclosed Thursday -- that doesn’t do much for confidence in the financial system.
As for those shrinking returns on safe accounts, recent history suggests it could take even lower returns to dislodge money from those havens.
The last time the Fed was in serious rate-slashing mode was 2001 to mid-2003 as policymakers sought to pull the economy out of recession, then keep it out. Savers painfully remember that the Fed’s key rate fell to a generational low of 1% in June 2003 and stayed there for a year.
One result was embarrassingly low yields on bank accounts and money market funds. The average money fund yield fell to about 0.5% in mid-2003.
Even as yields tumbled in 2002, however, money fund assets proved to be sticky. Cash finally began to pour out in 2003 in search of better returns. The funds’ assets fell $210 billion that year as Wall Street rallied after the start of the Iraq war.
How low does the Fed go this time around? Some analysts are betting on a return to 1% or thereabouts by year’s end because they believe the housing bust and resulting credit crunch will be an enormous drag on the economy.
But there may be a catch: The Fed’s decision to drive rates so low in the last credit-easing cycle has since been lambasted as a huge mistake because it helped inflate the housing and mortgage-debt bubbles. We all know where that got us.
The central bank, no doubt, would prefer to stop before it gets to 1%.
It might be able to stop sooner if investors quickly come to believe that stocks, despite all their risks, are a better investment than cash.
The Fed says it doesn’t pay attention to stock market swings in setting policy. If anyone believed that before, they surely don’t anymore, having seen the Fed’s emergency rate cut Tuesday follow a frightening plunge in Asian and European stock markets.
What happens next with interest rates now depends in large part on whether investors’ fear of losing out on a stock rebound trumps their fear of losing money.
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