Making hay from Fed's interest-rate hikes

Cash is definitely king now, thanks to belt-tightening by policymakers at the US Federal Reserve.

The Fed has pushed up short-term interest rates six times since June 1999. During that period, rates on money-market accounts have shot up 1 percent or more.

The average return on a money-market mutual fund account is now around 5.85 percent, says Peter Crane, vice president and managing editor of iMoneyNet, based in Westborough, Mass. "But in a couple of weeks, we expect the average rate will be over 6 percent. Some funds are already paying out that amount."

Yields on money funds are at their highest levels since April 1991, he adds.

While higher interest rates may not be a happy circumstance for the stock market - climbing rates put downward pressure on stock prices - they are "good news for income investors," Mr. Crane says.

Analysts at iMoneyNet (formerly IBC Financial Data) are now seeing the impact of higher rates on money flows. In the past three weeks alone, some $16.3 billion shifted into money-market accounts. That compares with the prior three-week period, when outflows reached almost $60 billion, largely the result of taxpayers using money-fund accounts to pay off tax bills, Crane says.

"As long as the Fed continues to raise rates, we will continue to see more money flow into money funds," he says.

The current increases in interest rates may not stem from the latest hike, he adds, but from prior ones. On May 16, the Fed announced a half-point increase. So there is some distance yet to go in terms of hikes pushing up returns in general, Crane says.

Most economists expect another rate hike when Fed policymakers meet this month. Even if they hold off, a hike cannot be ruled out in August.

Currently, savers have plopped more than $1.6 trillion into mutual-fund money-market accounts. In addition, another $2 trillion is in bank-related money fund accounts, including bank certificates of deposit. Banking officials are already seeing new dollars flowing into CDs as a result of higher rates.

At Astoria Federal Savings in New York, for example, six-month variable-rate CDs are now yielding 5.76 percent, up sharply from the past month. A conventional one-year CD is yielding 5.40 percent. In both cases, savers can buy in with as little as $500, a bank spokeswoman notes.

That's not bad considering through May 30 of this year, only 475 domestic US stock funds have returned 5 percent or more, out of 2,690 such funds, according to Chicago-based fund-tracker Morningstar Inc.

Whether investors should shift assets out of stock mutual funds to capture the benefits of money-market funds is a question that continues to reverberate.

Well-known long-term investment strategists such as Charles Schwab and Charles Carlson see risks in shifting monies out of stock funds - even slumping stock funds - since it is difficult to know when to "re-enter" a down market.

Historically, the bulk of major market gains in a new bull market can occur in just a few days, often near the front end of an investment cycle. To not be in the market during that period means to miss out. But some long-term investors see advantages in shifting at least a portion of their assets to tap the higher rates.

"The main advantage of moving into a money-market fund is that you've insulated yourself from equity [stock market] risk," says Sheldon Jacobs, editor of the No-Load Fund Investor in Irvington-On-Hudson, N.Y. Since late last year, Mr. Jacobs has been urging his clients to shift a portion of their portfolios out of the turbulent stock market and into the safer pastures of money funds.

Although stocks rallied back from their recent doldrums in the middle of last week, it is "possible that this is a bear market rally," Jacobs says. And even if the uptick is genuine, he says, "there are still a lot of technology stocks that have high price-to-earnings ratios." That means continuing market risk, Jacobs says.

"I'd wait to see what the Fed does in June and for some of the high valuations to be corrected" before moving cash back into the stock market, Jacobs says.

One often-overlooked alternative to both money-market accounts and bank CDs: short-term bond funds with durations of one year or less.

They are offered by most major fund families and can provide very high returns. Over the past five-year period, for example, short-term bond funds outpaced returns on taxable money-market accounts, according to Morningstar.

(c) Copyright 2000. The Christian Science Publishing Society