I have always been told to keep a portion of my savings in liquid investments such as a savings account, CDs or a money market account. However, for the last several years, I have earned almost nothing on these assets. When will interest rates go up? Should I move my cash?
If you are feeling depressed lately due to the low yields offered by relatively safe liquid assets, you are not
alone. Adding insult to injury is the fact that any income earned on these types of accounts: Certificates of Deposits (CDs), bank checking and savings accounts and taxable money market accounts, are taxed as ordinary income (rates may be as high as 35%). If you want more evidence of injury, take a trip to the grocery store to be reminded that at the current low rates, “safe” money is also being eroded by inflation.
Before addressing what may cause rates to rise, we should first understand why interest rates are so low right now. Short-term interest rates and bank account savings rates are determined by the federal funds rate, which is set by the Federal Reserve. In 2008, the Federal Reserve lowered the federal funds rate to its present yield of .25% in response to the financial credit crisis that was unfolding globally. The federal funds rate, according to the Federal Reserve’s website, “is the interest rate at which depository institutions lend balances to each other overnight.” Of course, banks lend out much of their cash to individuals and businesses at a rate higher than the federal funds rate, but think of the fed funds rate as an anchor. It holds down the short end of the yield curve and anchors rates along the curve based upon the length of those loans and the perceived risk. Today, risk-free rates, starting with the fed funds rate of .25%, are at some of their lowest rates in history. As of this writing, five-year treasury rate is at .75%, the ten-year treasury is yielding 1.7% and the 30-year treasury sits at 2.8%.
Although many pundits have expected interest rates to rise over the past two years, events keep getting in the way. In 2011, for example, Japan suffered a devastating earthquake and tsunami that threw the third-largest global economy (behind the U.S. and China) back into a short recession. In 2010 and 2011, the fear of a global credit crisis caused by Greece defaulting on its debt, and this causing a domino of defaults in the European Union, kept the level of angst high. Today, we are still in the midst of a European debt crisis that is pressuring global growth. There is growth in the U.S., but it remains slow and unsteady. If the fear of another recession is not enough to spoil your chances to earn a bit more on your cash savings, the Federal Reserve also points to very low rates of inflation as a reason to keep rates low.
So when will interest rates rise? At the latest meeting of the Federal Open Market Committee (FOMC), the FOMC indicated no current change in the level of short-term rates and that no change was expected until 2014. Longer-term rates, of course, may fluctuate upwards if the economy signals improvement, but rates on CDs, checking and savings accounts and money market accounts are likely to remain near zero for the foreseeable future. As for moving your cash in search of higher yields, to the extent that this savings is part of your overall investment strategy (emergency fund, cash for defined expenses, or cash for living needs), you should not be tempted to seek higher returns. There are other alternatives available, but reaching for yield simply to add a few percentage points of return on your cash investments may expose those assets to unacceptable downside risk or loss of principal.
On a positive note, the current rate environment certainly offers individuals and businesses the opportunity to lower their cost of carrying debt. If you do have debt, review how much you are paying for it, and take action to refinance your debt if it makes sense to do so.