Savers Switching Out of CDs Make Way for a Bull Run

A lot of cash is piling up in short-term accounts at banks and mutual fund companies. That could be setting the stage for another big rally in both stock and bond markets, some experts believe.

Until fairly recently, many Americans had been shoveling cash into certificates of deposits at banks and S&Ls.; As yields on six-month and one-year CDs began to follow market interest rates higher in February, 1994, many savers responded by favoring CDs over other options for their money.

Data from the Federal Reserve Bank of St. Louis shows that the total amount in small CDs (that is, CDs under $100,000) nationwide zoomed from $770 billion in February, 1994, to $918 billion by the end of June of this year, a gain of $148 billion.

But since then, some savers have begun to have second thoughts about locking up their cash in CDs. Small-CD assets have risen just $12 billion since the end of June, to $930 billion now.

Meanwhile, assets of taxable money market mutual funds have jumped by $41 billion since the end of June, to a record $615 billion now, according to fund-tracker IBC/Donoghue Inc.

And assets of bank and S&L; savings accounts, despite their abysmally low yields in general, have risen by $18 billion since the end of June, to $1.11 trillion, after falling $53 billion in the first half. The savings total includes passbook accounts and money market deposit accounts, the latter being banks' answer to money market mutual funds.


It's not hard to figure why people are favoring money funds and short-term bank accounts over CDs. First, CD yields have been declining since spring as banks have slashed rates in tandem with falling market rates. The national average yield on one-year CDs, for example, has sunk to 5.07% now from 5.79% on April 21, according to rate-tracker Bradshaw Financial Network.

Money market fund yields have fallen too, but not as dramatically because the funds have extended the maturities of the securities they own, to pick up more yield. The average fund's seven-day annualized yield peaked at 5.58% in April and is 5.20% now, IBC/Donoghue says.

Savers can do math: If they can earn 5.20% in a money fund that offers them immediate access to their cash, versus 5.07% to lock up their loot for one year, the money fund is the logical choice.

"People figure that with interest rates where they are, they'll park in a money fund and wait for a more attractive investment," says Irwin Kellner, economist at Chemical Bank in New York.

The risk, of course, is that short-term interest rates will continue to decline, dragging money fund yields ever lower well into 1996. If that happens, savers who lock up their cash at 5.07% for one year may look a lot smarter than those crowding into money funds today.

But how much lower can short-term rates go? Many Wall Streeters doubt that we're headed back to the days of 3% money fund yields, the level that prevailed in 1993. Although the Federal Reserve Board has begun easing credit again, the economy is hardly weak enough to justify significantly lower short-term rates, most pros say.

The "federal funds" rate, the benchmark short-term rate maintained by the Fed, was cut from 6% to 5.75% in early July, the first reduction in three years. William Sullivan, economist at Dean Witter Reynolds in New York, figures the Fed may shave another half-point off that rate over the next few months, if the economy stays sluggish and if Congress and the White House seal a long-term plan to balance the federal budget.

If Sullivan is right, money fund yields may bottom somewhere north of 4.50% next year. If CD yields slide in tandem, money funds may still be an attractive alternative to locking up cash in CDs.

But here's the big question: Will a decline below 5% on the average money fund's yield trigger a massive shift of that money into stock and bond mutual funds, in search of better returns?

Many investors have a threshold for pain with money fund yields, a return that simply becomes too low to endure. Whether a drop into the 4% range will be enough to drive investors out of money funds remains to be seen. But recent history suggests that if people begin to sour on money funds because of cheap yields, they won't take that cash back to the banks and buy CDs.

Instead, much of that dollar hoard is likely to be earmarked for stock and bond markets, both of which inevitably appear more attractive as short-term accounts grow less so.

Combine further Fed rate cuts with a moderately growing economy, low inflation and a balanced-budget promise, and it's easy to see a powerful new bull run on Wall Street--with small investors' cash providing the fuel.


Where the Cash Is

Over the last few months, cash inflows to money market funds and short-term savings accounts have picked up while inflows to bank CDs have slowed sharply.

Sources: Federal Reserve, IBC/Donoghue Inc.

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