For Savers, a Rate Cut Is Unwelcome
For income-hungry investors, the search for yield could become even more daunting.
If the Federal Reserve cuts its key interest rate today, as expected, the move is likely to further depress yields on money market funds, short-term Treasury debt and bank savings.
“It’s not a great time for savers,” said James Grant, editor of the newsletter Grant’s Interest Rate Observer in New York. “From the borrower’s point of view, low rates are a windfall. From the saver’s point of view, they’re a hazard. Among other things, they lure savers into taking risks they would otherwise avoid.”
Money market mutual fund owners -- and fund managers -- could be especially hard hit by another Fed cut: With average seven-day money fund yields at 1.21%, according to rate tracker IMoneyNet Inc., even a quarter-point Fed cut could mean the average would fall under 1%.
Some funds already pay far less than 1%, after expenses are deducted. Lower rates on the short-term corporate and government IOUs the funds buy could mean that more funds would be forced to eat management expenses to keep their yields from effectively going negative.
Yields on bank CDs and money market deposit accounts -- which like money fund returns are at or near record lows -- also would surely suffer from another Fed cut.
Short-term T-bill yields, which hit 44-year lows Monday, could go lower, although a quarter-point Fed cut already is “baked into” that market, analysts say.
In all, the Fed’s key rate at 1.5% -- the expected new level -- would leave many Americans earning virtually nothing on their cash savings. But with yields already so low, many investors may have stopped caring about returns on those assets.
“What do you do, put the money under your mattress or my mattress? At least if you put it under my ‘mattress’ I pay you,” said Bruce R. Bent, chairman of the New York-based Reserve Funds and a pioneer in the money fund industry.
Currently, 31 money funds are paying yields at or below 0.25%, said Peter Crane, editor of Money Fund Report, a publication of Westborough, Mass.-based IMoneyNet Inc.
If the Fed cuts its rate by a quarter point, about twice as many money funds would be “flirting with zero” within six weeks as the effect takes hold, Crane said.
A handful of funds recently have waived expenses to avoid “breaking the buck,” or letting share values drop below $1 (the equivalent of a negative interest rate), but dozens more might be forced to make the same move, Crane said.
“Money market funds increasingly are becoming loss leaders for the industry,” said Andrew Clark, senior research analyst at fund tracker Lipper Inc. in Denver. “That’s likely to continue.”
Money funds will take any steps necessary to avoid breaking the $1 share level, Bent said, because doing so would harm their image of stability.
Giant funds with modest expense ratios, such as the $57-billion Fidelity Cash Reserves, have plenty of room to maneuver, analysts say.
Retail and institutional investors have been fleeing money market funds this year, Crane said. Through September, a net $158 billion came out of the funds, according to the Investment Company Institute, the industry’s main trade group.
Bank CDs and money market deposit accounts haven’t offered much of an alternative, however.
According to Bankrate.com of North Palm Beach, Fla., CDs are averaging 1.53% for a six-month term, 1.73% for one year and 2.32% for 2 1/2 years, all record lows since the firm started tracking rates in 1984.
Money market deposit accounts at banks are at a record low average of 0.95%, Bankrate.com said. Banks typically trim their deposit rates in line with Fed cuts, depending on how hungry they are for deposits.
Still, “If you’re in the stock market looking at a 30% loss, like some people are, then a 1% return doesn’t look so bad,” said Karen Christie, vice president of research at Bankrate.com.
But the danger for both professional money managers and individuals is that dismal cash savings returns will push more of them to take on more risk than they can handle, reaching for higher returns in stocks or longer-term bonds, Grant said.
“Reaching for yield is one of the most dangerous acrobatic stunts an investor can perform,” he said, if the investor isn’t prepared for the risk involved.