What Lies Ahead For Money Market Accounts?

What Lies Ahead For Money Market Accounts?

August 2011 was a wild ride for US money market rates. The debt ceiling was raised on August 2, and Standard and Poor’s downgraded U.S. sovereign debt on Friday of that week. These developments did not impact the money market in the ways that outside commentators expected. In fact, investors seemed to rush to downgraded US Treasury bonds, pushing the benchmark 10-year yield close to 2 percent. Later in the month, worries about a second global downturn drove further demand for U.S. debt, pushing 10-year yields below 2 percent for the first time ever. (1)

These low rates have spelled out bad news for money market mutual funds and the money market in general. The money market is the place where short-term debt securities are bought and sold by corporations and banks. Banks use the market to fulfill reserve requirements and satisfy depositor demands. Corporations issue short-term debt securities to fund their operations and meet other obligations. The money market plays an essential role in the economy, and its freeze in 2008 spelled doom for corporations and banks before the Federal Reserve intervened.

Today, conditions in the money market are pointing to a renewed crisis down the road. Unlike 2008, the inflation rate as measured by the Consumer Price Index is much higher at 3.6 percent. (2) The Federal Reserve publicly committed to keep interest rates at near zero for at least another two years. These two developments are delivering a real beating to money market accounts and mutual funds. With real interest rates negative, money market accounts are losing value. Combining this with the intensifying European debt crisis and a scrambling for cash as a result of Hurricane Irene, the forseeable future of the money market is looking grim.

The Federal Reserve has effectively locked in the short end of the yield curve, forcing investors to pursue riskier assets at the longer end. With higher inflation and fears of European contagion, the money market has been shoring itself up recently. In fact, total assets have been decreased by over $2 billion as investors pull their money. (3) European government debt woes have undoubtedly played their part in this. If the European Union collapses under the weight of its own debt, several European banks may fail, sending a fresh wave of horror through financial markets.