By Barbara Cohen
Chief Information Officer, ShadowTraders
Access to money at a reasonable interest rate is what businesses and consumers have come to rely on to spur the economy. For this purpose, the Feds have lowered interest rates to bargain basement levels, hoping that this will serve as a catalyst for the country's lethargic business investment and hiring. By reducing borrowing costs for machinery and equipment, the Feds assume that new factories will be built, more stores opened and apartment buildings constructed, all leading to additional employment. Short-term reduction of interest rates as a stimulus to business spending is normal operating procedure for the Feds. But when interest rates hover at nearly zero for long-term, there are "unintended" side effects that do not benefit all.
At the beginning of 2008, the Federal Open Market Committee (FOMC) began reducing the Fed Funds Rate as a response to the global financial meltdown, first by 2 percentage points and then by summer to 3 points, until they reached almost zero, 0.25%. This has been going on for over 40 months now and is expected to last through 2014. The 10-year U.S. Treasury notes yield is 2.05%, less than inflation. Even the 30-year bond is yielding just 3.21%.
While reduced interest rates may help homeowners refinance their mortgages or entice commuters to purchase new cars, banks have left savers with little choice but to stop saving. The current 1-year CD rate available at most banks is roughly 1%. Even a jumbo 5-year CD pays less than 2%. For the millions of retirees, this poses a major problem, especially as more and more baby boomers join their ranks. In fact, low interest rates actually punish retirees who rely on interest income to survive.
Suppose a retiree has $500,000 in savings. At the current jumbo 5-year CD rates, that would produce an income (before taxes) of $8,500. Even the 30-year bond would only pay a pre-tax income of $16,000, certainly not enough to live on. It's as if the Feds are turning retirees into victims of their monetary policy. Keeping interest rates at this artificially low level has also spiked inflation, with gasoline prices soaring above $4.00/gallon, hitting retirees in the pocket yet again. Bernanke continues to claim that this inflation is "temporary" however 40 months is hardly temporary.
But there is one other major "unintended" result...money is now flowing out of the country in search of investments with higher rates of return.
Because Fed monetary policy has gone on for so long and is expected to last for yet another 12-18 months, many retirees feel they are being forced to take their money out of normal secured investment income sources and put it somewhere they hope can earn them a solid return...i.e. the skyrocketing stock market. Since the beginning of the year the S&P 500 is up over 11% while the Dow has gained 8%. Yields such as these are enticing to retirees who are experiencing 1% CD rates. Bottom line: the Feds are forcing retirees out of security and into high risk. But have the Feds pushed too far?
Last summer the Market dropped 2,000 points, down over 27% before it began its recovery. It has since experienced a very steep rise, and to retirees, it looks like a carrot being dangled in front of them just begging them to participate.
Unfortunately, it's almost May. We may once again see one of the most recognized Wall Street adages: "Sell in May and Go Away" play out and take retirees yet again. By April 2011, the Market had risen just over 6% before crashing 27%. In April 2012, the Market is up 8%.
Billions of dollars were lost last summer. Fear took the Market by storm as investors sold as fast as they could. What will happen again this summer?
The Feds are pushing retirees into the Market, forcing them to be "all in", just to earn enough income to survive. But not all retirees belong in the Market. Few, at best, can afford to weather a 2,000 point / 27% drop. Bernanke may be a gambling man, but The Feds should stop playing poker with the retirees lives.
Register Now to Attend a FREE Live Trading Event with Barbara Cohen on Tuesday, April 10, 2012 at 8 pm EDT.