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One ominous sign that another recession is looming

MarketWatch logo MarketWatch 11/1/2018 Brett Arends

Video by CNBC

Yes — cash is back.

Once again people who don’t want to take on the risks of the stock market or the bond market or the gold market or any other market — and just want a reasonable rate of return on their savings without having to worry — are starting to feel some love.

Interest rates on two-year certificates of deposit or CDs — not quite “cash,” but pretty close — have just cracked 3% for the first time since living memory. And rates on parallel two-year Treasury bonds are not far behind. Just a couple of years ago they were offering barely half a percent — and this minuscule rate of interest, of course, was fully taxable too.

These rates are already well ahead of the 2.2% overnight Federal Funds rate set by the Federal Reserve, as financial markets have already anticipated further rate hikes by the Fed, expected later this year and in 2019.

The surge in rates for deposits comes at a time when stocks and bonds are both suddenly looking distinctly rocky. And for the first time in quite a while, those buying CDs can beat inflation, which has averaged about 2.5% this year.

One woman’s trash is another woman’s treasure, so while Wall Street speculators freak out at the prospect of rising interest rates, and President Trump complains that the Federal Reserve is going “crazy” by putting rates back up, let’s not forget all for those whom rising interest rates are a matter of enormous relief. That means, above all, retirees, and those near retirement, as well as all those who are willing to accept lower returns for a lot less risk.

Right now my broker is offering me CDs paying 3% or better from six nationally known banks. lists one. All of these are insured by the Federal Deposit Insurance Corporation, which means up to $250,000 is covered even if the bank pulls a Lehman. Two-year Treasury Notes — IOUs issued by Uncle Sam, and freely tradable through any broker — are now paying interest rates of 2.84%. The last time we saw rates that high was in 2007 — almost a year before the Lehman collapse.

These two-year notes and equivalent 24-month CDs seem to be in the sweet spot in terms of length. They effectively lock in the next couple of interest rate hikes by the Federal Reserve, while taking on very little risk from inflation. They are paying nearly as much as 10-year Treasury Notes (which are currently yielding 2.84%).

The gap between the two has rarely been this low. Typically, longer-term bonds have to offer one or more extra percentage points of interest per year to tempt investors into a longer-term fixed rate of interest. The narrowing of this gap is widely seen on Wall Street as an ominous sign of a recession on the horizon. 

Cash is considered a four-letter word on Wall Street, figuratively as well as literally, because of the simplistic argument that cash-like securities — things like Treasury bills, savings accounts and certificates of deposit —have historically offered very low returns compared to stocks and bonds. It’s true up to a point, but it misses a lot.

Data from New York University’s Stern School of Business show that short-term Treasury bills, for example, failed to keep pace with inflation in the 1940s and 1950s, and again in the 1970s. On the other hand, they kept you ahead of the eight-ball in the 1930s, 1960s, and after the early 1980s.

Cash, of course, did very well during the financial meltdowns and market crashes of, for example, 1929-1932, 1987, 2000-2003 and 2007-2009. Research conducted for England’s Cambridge University last decade also argued that 20% cash, rather than bonds, was the best counterbalance to stocks in a long-term portfolio.

Whether cash outperforms stocks or bonds in the near future is something no one will know in advance. U.S. stocks are at historically elevated levels when compared to, say, the size of the national economy, or the corporate earnings of the past decade. Meanwhile bond market king Jeffrey Gundlach has warned that longer-term bond prices could fall a lot further.


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