What Causes a Decrease in Money Market Rates?
- Are they safer than keeping the money in your pillow?chair with pillow and rope image by Inhumane Productions from Fotolia.com
Money market returns--the returns both of the interest-earning bank accounts (MMA) and of the money market funds (MMFs), which in a sense compete with them--are the returns available for the most low-risk and highly liquid of investments. They have fallen for reasons relating to the policies of the central bank, on the one hand, and to the introduction of new regulations designed to ensure their solvency, on the other. - Competition between MMAs and MMFs may help hold rates up.competition image by Eugeny Shevchenko from Fotolia.com
MMAs and MMFs are in competition with each other for the pool of money that investors want to save in safe investments. MMAs, run by banks, have the advantage of being insured by the Federal Depository Insurance Corporation (FDIC). MMFs, which are not insured, must offer at least a slightly higher return than MMAs to attract customers.
Nonetheless, both see an influx of funds from the public when there is a "flight to safety." Thus, at the beginning of 2009, after the chaos of the preceding year, the amount of cash held in money market funds exceeded the amount held in equity-oriented mutual funds for the first time in a decade. - Returns are very sensitive to Federal Reserve policy.$1 house image by Paul Heasman from Fotolia.com
Both MMAs and MMFs are very sensitive to Federal Reserve policy, which generally is to keep credit cheap in recessionary times, in the hope that this will stoke the flames of industry. On the other hand, when the Fed tightens credit, in the hope of checking inflation, it increases the rates that MMAs and MMFs can offer investors.
The long-term trend, through several recent business cycles, has been toward lower money market rates. The rise in the later stages of boom times when the Fed seeks to check inflation does not, in general, compensate for the fall in bad times when the Fed seeks to keep credit easy and the overall direction remains down.
Money market accounts were paying more than 6 percent interest at the end of 1988 in contrast to 1.25 percent in the middle of 2010.Such declines, which exceed what can be attributed to the business cycle, are known as "secular" trends. - SEC now requires stress testing of portfolios.woman in stress image by csaba fikker from Fotolia.com
The secular decline can be explained in large part by the increased regulatory load that the institutions that manage such accounts have had to bear.
For example, in June 2009, the Securities and Exchange Commission adopted a set of new regulations for mutual funds, including a mandate for periodic "stress tests." These rules will necessarily increase costs for the sponsors of such funds, and very likely decrease yields.
Flight to Safety
Federal Reserve Policy
Regulatory Demands
Source...