Picking up Nickels

Monday, October 26, 2009

Fixed-income outlook for 2010 and beyond

I was reading about the plight of savers at the Bank Deals Blog last week and was sadly reminded about how much interest rates have dropped over the past two years. While I can certainly understand how savers like me are disappointed about current fixed income rates, I was particularly disappointed by the amount of misplaced anger demonstrated by commenters there. One particular anonymous commenter seemed to make a few posts pointing the finger at President Obama followed up by more anonymous posts agreeing with himself.

I was moved to leave a comment there indicating that the beginning of the recession as well as the cuts to the FOMC target rate resulting in the current near-zero level all occurred
before Obama even took office, but obviously that was not well received. The first thing that anti-Obama sentiment made me think of was this humorous political cartoon by Mike Luckovich of the Atlanta Journal-Constitution:



That being said, I stand by the assertion that I made in my comment on the Bank Deals Blog:

It is sound monetary policy to lower interest rates to help facilitate an economic recovery. When the cost of borrowing is low, economic activity is generated by businesses and individuals buying vehicles, equipment, real estate, etc.

During the recession of 3/2001-11/2001, the FOMC lowered the federal funds rate from 5% to 2% to do just that. While one can argue that they kept low rates in place far too long (helping pump up the housing bubble), the resulting low savings rates were accompanied by low auto and home loan rates that stimulated a lot of economic activity.


With that in mind, let's check out what happened to my savings rates during the previous recession lasting from March 2001 until November 2001. For data, I'm using the interest rate earned on my E*Trade (formerly Telebank) Money Market account during that time:



As the above graph shows, the 4.69% rate I was earning when the recession began in March 2001 quickly collapsed along with the FOMC target rate as both stayed pathetically low for about three years after the recession ended in November 2001.

This data pretty much shows that interest rates were lowered during the last recession as a way to stimulate borrowing, which ultimately leads to increased economic activity. I certainly took advantage of that low rate environment (as well as other incentives) to buy a new car and refinance my mortgage to the 5.375% fixed rate mortgage that I still have today. And no, that wasn't President Obama's fault either. :p

Now let's look how rates fared during the current recession using the ING Direct Orange Savings rate during that time. However, we don't know if we're out of the current recession yet, so I am making the assumption that we are still in a recession until we know otherwise:



Once again, we can see a precipitous drop in the ING Direct rate and the FOMC target rate once the current recession began in December 2007. The worrisome part is that with a near-zero FOMC target rate (represented as 0.25% in my graph), the interest rate on the ING Direct account could potentially drop quite a bit lower before rates stabilize. Even worse, we could be looking at low rates on our savings accounts through late 2012 if the game plan from the previous recession is any indication.

As a saver, I think that we're looking at low rates on our money for quite some time. There may be a few opportunities here and there (particularly inflation-indexed ones like TIPS and I Bonds), but I fear that those opportunities will be far and few between.

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