Fed sends a signal for us to save more

Higher interest rates discourage betting on stocks, bonds

Your Money

October 30, 2005|By TOM PETRUNO | TOM PETRUNO,LOS ANGELES TIMES

The way Wall Street moans about rising interest rates, it would seem that no good could come of them.

Tell that to people with cash in the bank or in a money market mutual fund.

When Federal Reserve policymakers meet Tuesday, they are almost certain to raise their benchmark short-term interest rate a quarter of a point, to 4 percent. It would be the 12th increase since mid-2004.

That move should assure that rates on bank certificates of deposit and money market accounts will continue to move up as well.

Certainly, nobody's in danger of getting rich off single-digit bank yields. Still, this is the best that savers have had it in four years. And given the poor returns on U.S. stocks and bonds this year, people who prefer to play it safe may be feeling rather smug.

The average domestic stock mutual fund has lost 0.5 percent year to date, according to Lipper Inc. The average long-term bond fund is up 0.7 percent.Compared with those results, the 3.2 percent annualized yield on the average money market fund sounds enticing.

There may be something more important afoot in the return of (barely) respectable interest rates on cash accounts: They provide an incentive for many Americans to do something they haven't done enough of for the past couple of decades, which is to save money.

It isn't a coincidence that safe and conservative cash accounts are becoming a more attractive asset. The Fed, in raising interest rates and tightening credit, is in effect telling us to be warier about taking risks.

This is the opposite of the message in 2002, 2003 and the first half of 2004, when the central bank held interest rates near rock bottom. The goal then was to push people to take risks in the stock, bond and housing markets as a way to jump-start the weak economy. And the plan worked.

Now, by continuing to raise rates - officially in the name of fighting inflation pressures that have been made worse by high energy prices - the Fed is depressing stock and bond prices overall.

Fed Chairman Alan Greenspan has engineered this strategy, but it will soon fall to his successor to either continue it or change it. President Bush last week nominated Ben S. Bernanke, chairman of the White House's Council of Economic Advisers, to replace Greenspan beginning Feb. 1.

Neither Greenspan nor, presumably, Bernanke would want to trigger a recession. They're hoping for the proverbial soft landing: They lift rates enough for economic growth to slow, damping inflation, and then at some point in 2006 begin to ease credit again.

But if things go wrong, and the economy stumbles badly, cash will look even better as a hiding place, at least for a time.

Much, or maybe all, depends on how American consumers react to the Fed's shift and the fallout.

If enough of us are losing either the ability or willingness to spend money, the chances increase that the economy next year will be weaker than the Fed would hope.

That would be a recipe for a sinking stock market and a troubled housing market - which, in turn, could encourage more people to direct any savings they have to safer places, where returns may be relatively low but loss of principal is unlikely.

Betting against Americans' desire to spend money has been foolhardy for most of the past 25 years, but some economists believe there are good reasons to believe that many consumers are ready to tighten their purse strings.

The Fed doesn't want spending to collapse. But in continuing to raise short-term interest rates, it's also offering a reward, of sorts, to consumers who want to repair their own balance sheets by raising their savings levels in no- or low-risk accounts.

Tom Petruno writes for the Los Angeles Times.

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