Tuesday, May 19, 2009

On my terms

During the market and economic collapse of last fall, I warned towards the end of the year that with all the money flowing into the banks, I expected that the interest rates the banks would pay on savings would begin to fall after the first of the year. Here we are in late May and rates are still falling around the world for deposit accounts. If you look at the chart above, you can see how fast the 1-month interest rate investments have fallen. Look at the rates just 6 months ago and compare it to the current short-term interest rate.

LIBOR stands for the London Interbank Offered Rate (LIBOR).The LIBOR rate is the rate of interest banks charge to each other in London, England and it is the benchmark for the rate of interest pricing for institutional depositors and loans around the globe.

As you can see above, the one-month LIBOR interest rate has dropped over 30% in the last month and in the last 6 months it has declined 450%. Part of this decline in LIBOR is based on the Bank of England and the European Central Bank cut in interest rates since the beginning of the year. In addition, the amount of money the central banks have put in circulation has made the bank flush with cash. If they do not need the cash to lend out, they will drop the interest rates they are willing to pay to attract deposits and that is exactly what they are doing.

The impact of these falling interest rates is lower and lower rates on traditional money market funds and of course, US Treasury Money Market Funds. According to Barron’s On Line last weekend the average money market fund yield was 18 basis points, which included the waiver of some of the fees and operating expenses. As more and older assets are replaced with lower and lower returns, the yield on these funds will continue to drop.

Declining gross yields means that more and more managers are paying fund expenses out of their own pockets. Currently, we have about $4 trillion in money market funds in the United States. The US Government Money Market Funds comprise about $1.4 trillion in assets. The investors are making close to zero return and the managers have waived their management fees and are now paying some of the expenses to keep the fund at $1.00 Net Asset Value (NAV). The managers are losing on these funds and if interest rates don't go up soon I believe managers will begin closing funds and returning capital to investors who will have little choices for their money.

Most of the non Treasury Money Fund managers are waiving some or all of the management fees and they are stretching for yield to cover expenses. We have 38 million Americans that own money market funds and are earning very little return. You can earn more on your money at the banks, but that window to get higher yield is quickly closing.

I do not believe that cash investments will see any significant increase in yield for several years to come. You will always have a need for cash investments, but unlike the past you cannot go there and hide and rebuild your capital today. In the wonderful Charles Dickens novel, Oliver, there is a passage when Oliver gets his first meal and he says,” Could I have more please?” . The banks for now do not need your money and their answer is, I will pay you “on my terms”.


Dan Perkins

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