Allure of Rising Returns Draws Investors Into CDs
Fed interest rate hikes make CDs and money funds attractive again
THEY'RE back! Following the recent interest rate hike by the United States Federal Reserve Board, millions of Americans are putting their money back into bank certificates of deposit and money market mutual funds.
In an effort to quell future inflation, the Fed has steadily boosted interest rates since February, including this week's increase in two key rates: the federal funds rate, which banks charge each other for overnight loans; and the discount rate which the Fed charges banks for loans. Not surprisingly, investors are taking advantage of the higher rates by pouring billions of dollars into money market funds and CDs.
For example, an official at the Greater New York Savings Bank in New York says that deposits have been steadily flowing into the bank this week since the interest rate on its 18-month CD was upped from 5.41 percent to 6.17 percent. The yield on the 18-month CD is now 6.35 percent.
But the bank has also raised the minimum ante. To qualify for the higher rates, investors must plunk down $5,000 rather than $500.
Other banks are making similar changes and boosting CD rates.
``We've just identified some 13 major financial institutions around the US offering a yield of 6 percent or better on one-year certificates,'' says Hugo Ottolenghi, editorial director of Bank Rate Monitor, a weekly financial journal in North Palm Beach, Fla. ``Rates and yields are going up'' on CDs, he says, and new money is flowing in. He predicts that the uptick in both rates and money is not over yet.
A VERAGE national yields on one-year CDs have been rising steadily all this year, Mr. Ottolenghi says. In January, for example, the average yield stood at 3.08 percent; by March it was up to 3.17 percent; by July it was 4.06 percent. The current average is 4.89 percent.
In the first few months of 1994, there was a decline in money held in certificates of deposit. Then those rising rates began to suck in new deposits. Since June, some $23 billion has flowed into CDs at commercial banks and savings and loan associations, according to the US Federal Reserve. Currently, the nationwide total held in CDs is some $793 billion.
For many financial institutions, CDs are attractive because the interest they pay on them rises more slowly than the rate they charge on business and other loans. When that interest rate spread widens, bank profits rise.
The pattern of rising rates and yields - and increasing levels of investment - is also occurring within money market funds. For the week ending Nov. 9, assets in money funds totaled $625 billion, up from $593 billion in late September, notes the Investment Company Institute, a mutual fund trade group in Washington.
``We've had seven consecutive weeks of asset gains,'' for money market funds, says Ralph Norton, managing editor of IBC/Donoghue Inc., in Ashland, Mass., a financial information company that publishes the ``Money Fund Report.''
Yields on top performing money market funds are now running about 5.5 percent, with the average yield on taxable funds now at 4.41 percent, Mr. Norton says. But Norton believes that by sometime early next year top performing funds will be ``closing in on a yield of 6 percent, with the average fund at about 5 percent.''
That latest rises put current yields well above the inflation rate, as measured by the consumer price index; the annual inflation rate is currently running at 2.6 percent.
Many economists expect additional rate hikes by the Fed, perhaps as early as December, but certainly by early 1995.
The expectation is partly based on prior Fed actions. During the past 50 years, whenever the Fed has raised the discount rate a third time, as they did this week, it has gone on to post additional hikes in 66 percent of the cases, according to James Stack, editor of InvesTech, a financial newsletter.
In most of those cases there were two or more additional rate increases, Mr. Stack says.