Money Fund Yields Fall With Fed Cuts, but Cash Pours In

With short-term interest rates dropping, yields on money market mutual funds are at their lowest levels in four years--and they’re expected to fall further.

Despite this trend--and the fact that stocks have risen for six consecutive sessions--investors continue to pour money into these ultra-safe funds at record rates.

The question is whether they will continue to plow money into these funds once yields fall below those of bank certificates of deposit--which at this pace could happen within weeks.

The average seven-day compound yield on a taxable money market fund now is 4.82%, down from 4.89% the previous week, IBC Financial Data of Ashland, Mass., said Wednesday. That yield is expected to drop to 4.5% in the coming month, once the full effect of the Federal Reserve Board’s most recent interest rate cuts is felt.

And should the Fed slash rates again, as many expect now that the central bank is attempting to stave off recession in 1999, “we could be looking at rates of 4% or less going into next year,” said Peter Crane, managing editor of IBC’s Money Fund Report.

Yet money fund assets jumped more in the last four weeks--they grew by $58.2 billion, bringing total assets to a record $1.3 trillion--than in any four-week period in history.

And many mutual fund companies are reporting cash flows into these funds at rates close to, if not matching, August--a month when the stock market tumbled and nervous investors aggressively converted equity stakes into cash.

But while it’s true that most shorter-term savings yields are falling, money fund yields are expected to fall further and faster than CD yields.

According to RateGram Inc., which tracks savings yields, the average yield on a six-month CD now is 4.56%. On a one-year CD, it’s 4.77%.

Says Martin Bradshaw, head of Bradshaw Financial Network in San Francisco: CD yields “really can’t go much lower or there wouldn’t be any incentive for investors to put their money in them.”

“Between now and the end of the year, I can’t see [CDs] going down more than 10 basis points,” Bradshaw added. That would put one-year CD yields at about 4.67%.

One reason CD yields aren’t expected to fall much more is that CDs lock in savers’ money for six months, a year or longer. Because CDs offer investors little or no liquidity--unlike money funds, which allow investors to move in and out at will--banks know they must offer decent yields to attract and keep savers.

And because of that lack of liquidity, Charles Biderman, president of the Santa Rosa, Calif., research firm Trimtabs.com, said he believes the bulk of money fund cash won’t flow to CDs even if CDs are delivering better returns.

“The yield of money funds is not as relevant as the safety, and really the ‘parking’ aspect,” said Biderman, referring to the ability of investors to park their cash in money funds while waiting for the stock market to stabilize.

An investor’s decision to go with a CD or money fund at this point should be based on whether he or she cares more about liquidity or guaranteed yields with federal deposit insurance, financial planners say.

Although money funds are considered very safe, they aren’t federally insured like CDs. And because money funds invest in short-term bank deposits, Treasury bills and corporate IOUs, their yields must follow market trends: In a falling rate environment, as short-term debt matures the funds must reinvest their cash at ever-lower market rates.

This is not to say that higher yields can’t be found in money funds. The Milwaukee-based Strong family of funds, in an attempt to lure investors, has waived all management fees on its Strong Investors Money Fund through January. As a result, the fund currently yields 5.63%, far above the industry average.

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MONEY FUND YIELDS: C11

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Shrinking Yields

Money market mutual fund yields are falling rapidly, following the Federal Reserve Board’s recent interest cuts. Money fund yields will soon be below current average bank CD yields, experts say. A comparison:

Money Fund yield*

Sept. 24: 5.10%

Now: 4.82%

Average CD yields

1-year: 4.77%

6-month: 4.56%

* Seven-day avg. compound yield for taxable money funds.

Sources: IBC’s Money Fund Report, RateGram.