Money Fund Yields Slide to New Low After Fed Cuts

Money market fund yields dropped to a record low Wednesday, pushed down by recent Federal Reserve rate cuts and by investors’ rush to safer investments.

The average seven-day simple yield on taxable money funds tumbled to 2.55%, down from 2.98% a week ago and the lowest level since the funds were invented 30 years ago, said Peter Crane, managing editor of IMoneyNet.com, which tracks money fund returns.

The previous low was 2.59% in May 1993. Just a year ago the average fund yielded 6%.

Yields on tax-free money funds fell to 1.74% this week from 1.80% a week ago and now are just above the low of 1.72% in January 1994. A year ago, investors enjoyed tax-free yields averaging 3.53%.

The sharp decline in taxable fund yields means investors’ real returns, after inflation and taxes, are below zero. Even so, investors unnerved by last week’s stock market plunge poured cash into money funds, which historically have been ultra-safe investments. Money funds took in a net $57 billion last week--the second-largest weekly inflow since the first money market fund was established Oct. 8, 1971, Crane said.

Crane, quoting Depression-era humorist Will Rogers, said investors are “more concerned with the return of principal than the return on principal” right now.

“Safety and liquidity have definitely taken precedence over yield,” Crane said.

The rush to safety moderated this week, with a net of $1 billion leaving money funds so far, Crane said.

Bankrate.com, which tracks rates on certificates of deposit, said CD yields also have tumbled to the lowest levels since the company began monitoring the rates in 1984. One-year CDs now average 2.94%. A year ago the average was 5.65%.

“A year ago, demand for loans was extremely high, which fueled CD rates to the highest they’d been in five years,” said Greg McBride, Bankrate.com analyst. “Banks are a lot more skittish today.”

Earlier this week, rates on short-term Treasury securities dropped to 40-year lows. Monday’s Treasury Department auction saw rates on three-month bills drop to 2.38%, the lowest since November 1961, while the six-month bill fell to 2.36%, the lowest since April 1961.

The precipitous drop in yields reflects eight Federal Reserve interest rate cuts this year as well as the central bank’s actions to protect the economy in the wake of the Sept. 11 terrorist attacks.

The Fed cut its key short-term rate target by one-half percentage point Sept. 17 to 3% but allowed the rate to drop as low as 0.5% last week while it flooded the banking system with cash.

That, in turn, drove down yields on short-term securities issued by companies and government entities--the type of securities owned by money market funds.

Meanwhile, greater economic uncertainty means banks are making fewer loans and thus not competing as aggressively for CD deposits, McBride said.

The big surge in money market fund inflows also is working to push down rates as managers scramble to put the new money to work in a lower-rate environment. One fund manager was forced to buy a short-term security that yielded a mere 0.25% last week, Crane said.

Money fund yields may rise slightly in coming weeks if the Fed turns off the tap of emergency cash, but continuing economic weakness is likely to mean the Fed will keep rates in general low for some time, analysts say.