Treasuries showed strength this week, with Treasury bond yields staying low despite continued supply via auctions. The Fed has signaled on many occasions that it expects rates to remain low for some time. This week it was the Fed Vice Chairman Donald Kohn who said that a “large and rapid rise” in short-term rates is unlikely because of slow or no worlwide economic growth and the lack of inflation. Indeed mortgage bond yields declined to their lowest levels in 3-months and mortgage rates are expected to follow these yields down.

Still with government borrowing expected to accleerate to fund the $1.85 trillion deficit, some analysts expect rates to rise as the supply of Treasuries overwhelms demand, forcing the government to raise the rate it offers to attract more buyers. That combined with some stirrings in the economy is the only hope at the moment that rates will rise in the medium-term.

So, far the data doesn't show any significant change in the current low-rate environment. As the chart below shows, long term 5-year CD rates seem to have largely stabilized with the average according to the BestCashCow rate table stabilizing in the 3.3% APY range. Rates on other products and terms though continue to drift lower. At this point, unless there is a significant uptick in inflation or economic growth, it's hard to see any change to this dynamic. While rates have pretty much stabilized, they have stabilized at a pretty low level. And at this point, if rates are going to move, it looks like they will still move gradually down.

There's no significant change to report in the spread between savings rates and 36-month CDs. The spread ticked up a bit but nothing that isn't within the normal range of the past few months. Notice that the spread between savings and 3-year CDs that we saw widen in the spring is still there, a sign that the economy is poised for expansion. One wonders who will blink first: will longer term CD yields come down in the absence of any sign of inflation, or will short term savings and CD accounts rise as the economy strengthens?

Based on this data, it would seem that any rate increases won't come until sometime in 2010. I would stay short-term and wait. An improving economy and a glut of Treasury debt will eventually put some pressure on rates.

The spread between the average BestCashCow savings rates and 36-month CD rates remains steady as the economy stabilizes and investors, banks, and consumers wait to get the next read on where the economy is going.

Congress is now turning its attention to the enormous $27 billion bank overdraft market and is considering legislation to alert customers when they are about to overdraw an account. Banks are fighting back, since overdraft fees are a big component in their business and profitability.

The overdraft market is an enormously profitable piece of a bank's revenue. According to a NY Times article on overdraft fees, banks make more on overdrafts than they do on penalty fees from credit cards. I can confirm this importance from my banking days. I remember sitting in meetings where potential changes to overdraft policy were discussed very gingerly because of its importance to the bank's revenue. Banks know that overdrafts diminish customer satisfaction but at the same time they are addicted to this "easy revenue."

Several pieces of overdraft reform are working through the Fed and Congress. The Fed is considering requiring banks to get customer permission before enrolling them in an overdraft program. And Representative Carolyn Maloney from New York has introduced legislation that would require banks to alert customers if a transaction is going to overdraw an account.

The banking industry is painting a dire scenario. From the Times article:

“Michael Moebs, an economist who advises banks and credit unions, said Ms. Maloney’s legislation would effectively kill overdraft services, causing an estimated 1,000 banks and 2,000 credit unions to fold within two years. That is because 45 percent of the nation’s banks and credit unions collect more from overdraft services than they make in profits, he said.

“Will they be able to replace it with another fee?” Mr. Moebs said. “Not immediately and not soon enough.”

Banks say that without overdraft fees, they may have to start charging for free rewards checking accounts. Bankdeals makes the case that reward checking accounts may not be profitable for banks without the funds from overdraft/NSF fees.

“This marketing brochure from BancVue compares the NSF revenue from free checking and reward checking. It shows that NSF revenue is actually a little higher for reward checking than for free checking. In both cases, NSF revenue is much higher than revenue from debit cards.”

To add another wrinkle, banks have been slapped for trying to “game” how transactions settle, potentially increasing the number of overdraft fees. Bank of America reached a settlement last year for allegedly changing the order in which transactions settled in order to increase overdraft fees.

Much of the discussion over this will come down to personal responsibility versus the bank’s responsibility to be fair. Those that advocate personal responsibility will say that consumers should know how much they have in their account and that if they are overdrawing it is their fault.

Others, such as one commenter on Bankdeals will make the case that:

“a lot of banks aren't really in the banking business at all - they're in the Gotcha Fee Collection business.”

My feeling is that if a consumer does not have money in their account, the transaction should not go through. Debit card transactions clear differently from a written check. When writing a check, a merchant is taking it on faith that there are funds in the account to prevent it from bouncing. The check is cashed after the goods have been exchanged. If the check bounces, the bank has to reverse the transaction and potentially deal with the merchant who was never paid for the service or good they sold.

But debit cards don’t work that way. The card can be checked before the exchange is made to ensure there are sufficient funds. It’s at that point that the bank should terminate the transaction if sufficient funds don’t exist. In that case, the merchant is not out of the good and the bank does not have to reverse a transaction. There is no bounced check.

Obscuring a lack of funds is like a gas company from hiding the gas low indicator in a car and then charging $100 for an emergency tank fill when the car stalls. It may be good for the income statement, but it’s a terrible way to build customer loyalty.

See savings rates here.

Even as the economy continues to show signs of firming and the stock market continues its upward trend, the rate on savings accounts and many CDs continue their downward movement. It's clear that until the Fed raises the Fed Funds rate, money markets, cds, and savings accounts will pay low yields. The only consolation is that inflation remains low, meaning the actual inflation adjusted return is higher.

As the chart below shows, savings as well as 12-month and 36-month CD rates moved down again last week to their lowest levels since we began tracking rates. The slope of the decline has slowed and is now more like a slow downward drift. It seems that like the economy, that we have probably hit bottom, or are close to it. The average savings rate according to the BestCashCow rate tables has fallen from 3.64% APY last year to 1.77% APY today. The rate you'll have find at your corner bank is probably a good deal lower.

There's no significant change to report in the spread between savings rates and 36-month CDs. The spread ticked up a bit but nothing that isn't within the normal range of the past few months. Notice that the spread between savings and 3-year CDs that we saw widen in the spring is still there, a sign that the economy is poised for expansion. One wonders who will blink first: will longer term CD yields come down in the absence of any sign of inflation, or will short term savings and CD accounts rise as the economy strengthens?

I still think that the bias is towards rate increases later in the year so I would stay short-term and wait. An improving economy will force the Fed to eventually raise rates, and that will cause yields to start rising.

The spread between the average BestCashCow savings rates and 36-month CD rates remains steady as the economy stabilizes and investors, banks, and consumers wait to get the next read on where the economy is going.