Could yields for money market fund see 6 percent?

Could yields for money market fund see 6 percent?

Some retail money market funds are on the verge of cracking 5 percent returns, and experts suspect 6 percent might not be far behind.

Meanwhile, certificate of deposit (CD) yields and high-yield savings accounts, which have been galloping along, may slow a bit as banks need to concern themselves with both the short and the long end of the yield curve. Money funds, on the other hand, focus strictly on the short term and might be in a better position to pay even higher yields if the Fed continues to raise interest rates.

I would never bet on anything, including Fed rate hikes, says Peter Crane, president and publisher of Crane Data's Money Fund Intelligence. But I'm predicting a quarter-point (hike) for every (Fed) meeting the rest of the year. That's barring any new information. They always say past performance is no guarantee of future returns, but there's no better source for guessing.

The onus is on people to say why the Fed should stop. They've been rolling along with the quarter-point hikes, and the fact that real estate and the economy have stayed as strong as they are is stunning.

Rate increases stimulate?

Crane points out that while rate hikes are undertaken to slow the economy, in the savings world, rate hikes actually have a stimulative effect on the economy that could add fuel to the inflation fire.

Every point the Fed raises rates creates about $50 billion in annual interest income. Higher rates and a slowing economy don't seem to be happening just as lower rates and a faster economy didn't seem to work. I think the stimulative impact of higher rates and the restrictive impact of lower rates haven't been given their due.

Edward Gjertsen, a certified financial planner based in Glenview, Ill., is among those who think the Fed will pause after the June meeting.

We're at risk of the Fed overshooting. I think we'll see 25 basis points in June and then they'll take a break unless something dramatic happens on the oil front, which the Fed can't control. I don't think the Fed wants to be too aggressive.

MMA rates on par with CDs

The Fed meets five more times this year. Even if the fed funds rate isn't hiked at every meeting, money market funds, which generally lag CDs because of the liquidity factor and the expense ratio, are already running neck and neck with some of the top-yielding CDs.

Both a one-month CD and a two-month CD at IndyMac Bank earn an annual percentage yield (APY) of 4.75 percent, according to Bankrate.com's survey of high-yield CDs. Four of the more popular retail money market funds are showing seven-day yields in that neighborhood.

Popular retail money market funds

Company 7-day yield (%) Expense ratio (%)

Schwab Value Advantage Money Fund 4.86 0.35

Vanguard Prime Money Market Fund 4.83 0.30

Fidelity Money Market Fund 4.72 0.42

Fidelity Cash Reserves 4.68 0.43

(Note: yields are net of expense ratio)

Many banks have been steadily ratcheting up yields on short-term CDs and high-yield money market or savings accounts. But, as mentioned, since they do business on both the long and short end of the yield curve they might have to become less aggressive on the short end as the yield curve will presumably shift from inverted or flat to a more normal slope. But until then, the battle for cash and customers continues.

It's not just the highly advertised accounts offered by institutions such as ING Direct, HSBC and Emigrant Direct that are trying to woo consumers with attractive yields. Cambridge Savings Bank in Cambridge, Mass., plowed through the 5 percent barrier with a stunning 5.15 percent savings account that's available only to people who live in communities served by the brick-and-mortar bank. Customers must pony up a hefty $25,000 to open the account, but the rate is guaranteed through February 2007.

Attractive liquids

One of the attractive components of this account is that it's liquid. Customers can add and withdraw deposits at any time. Our emphasis is to attract core customers. That's why we're not looking to broaden beyond our geographic marketplace, says Gary Coltin, executive vice president of consumer banking.

Look for bank savings accounts and money market funds to become more popular if the recent stock market volatility continues. If inertia has kept you from opening an account at an institution that offers a high yield savings or money market account, there is no better time to get going.

As rates rise, cash accounts that offer a decent yield are an attractive safe haven. But as Crane points out, consumers shouldn't overdo it. The amount of money you keep in a high-yield cash account should be based on risk tolerance and time horizons.