Lower rates will pinch creditors, savers even more.
By Amanda Cooper
06/23/2003
Reuters English News Service
NEW YORK, June 23 (Reuters) - The Federal Reserve seems poised to cut interest rates to 45-year lows this week, which would offer a boon to borrowers but tighten the screws on lenders or savers, analysts say.
The Fed could cut at least a quarter point off its 1.25 percent federal funds rate to boost the economy.
Cheaper money means consumers can spend more freely and companies can borrow to invest, offering the economy a lifeline when growth falters.
But the financial sector, including pension funds or even banks, will soon feel the pinch of low rates as lenders watch their returns shrink without much chance of capturing higher yields elsewhere.
"This is the vast class of overlooked investors who are losing out, and they're primarily losing out because of mortgage refinancing" said Chris Low, chief economist at FTN Financial.
A three-year downturn has pushed Treasury bond yields to record lows, unleashing a raft of corporate borrowing and allowing home-buyers to secure cheaper mortgages.
"We tend to think about mortgage refinancing in terms of home owners who are saving thousands. But you've got to think of someone on the other side who owns that mortgage. We pre-pay and they literally see the asset disappear from their portfolio," Low said.
"These insurance companies and pension funds (are) earning far less than they ought to be."
PENSION FUNDS UNDER PRESSURE
Pension funds and insurers have been choked by declines in stock markets and often must pay out a higher return while their investments have slumped in value.
Low rates mean investment proceeds must be reinvested for increasingly smaller returns, although insurers have offset lower returns by charging higher premiums, largely because of the overall rise in insurance costs after the Sept. 11 attacks, analysts say.
Money market funds, which trade in low-yielding short-term debt like Treasury bills, have been particularly hard-hit.
"If interest rates drop by another 25 basis points, there's no room to cut the rates money market funds pay," said Charles Lieberman, chief investment officer and economist at Advisors Financial Center in Suffern, NY.
"So what they'd end up doing is swallow some of their costs so that at least they pay investors something greater than zero, and that might cost them a great part of that business as people move their money into bank deposits," he said.
Banks are also not immune to the effects of lower rates. Many are straining to close the gap between returns on their investments and the higher rates they must pay to deposit-holders.
"If the Fed cuts rates again, these banks will end up charging less on loans but will be unable to pay much more on deposits. Their spread will narrow and that determines their profit margin," Lieberman said.
A sustained period of low rates and low inflation eventually undermines wage growth, making it harder to pay back a loan, even though interest-rate payments are smaller.
SAVERS PINCHED
Similarly, anyone saving for retirement or a college fund will need more money to meet their targets, especially if they own bonds that yield less over time as rates fall.
"No question, anyone who's got investments in bonds, particularly the elderly... and has money parked in interest-paying bonds, is finding it harder and harder to make ends meet," said FTN's Low.
"Safe-havens" like short-dated bonds or money market funds are yielding about 1.0 percent, which could lure investors into the stock market for better returns at a time when the economic outlook is still uncertain.
Edward Altman, a professor of finance at New York University's Stern School of Business, said investors could be tempted to assume more risk.
"They could put their money in high-yield junk bonds and they have been, and that's what's been driving the motivation to invest in that market. Certainly they can put it in the stock market again," he said.