Above 5% Yield Going Away!

Since Fed started hiking short term interest rate in mid-2005, customers of some online banks and credit unions have been enjoying increasing yield in their savings and money market accounts while taking the benefit of easy access to liquid cash. Banks like EmigrantDirect, HSBCdirect were offering above 5% yield with no minimum balance requirement. In certain intervals, their rate even touched 6% APY.

Some people even made quite a good sum by borrowing money from credit cards offering 0.0% interest rates or some other minimal number and putting that in high yield CD accounts in banks like IndyMac.

But with recent rate cuts in short term interest rates, that honeymoon seems to be drawing an end. Most banks have pulled back their rate to below 5% APY. Three major players in online banking that impose no minimum balance requirement, EmigrantDirect, HSBCdirect and IngDirect are offering 4.75%, 4.5% and 4.3% respectively in their savings accounts. Some money market accounts are still offering high rate. For example, the current rate in PayPal money market is 5.2% APY. The Fed rate cut has also affected CD rates. IndyMac is currently offering 5.4% APY only on its 5-month and 6-month CDs and 5.1% APY on 1-year CD.

If the Fed cuts rate further in their next meeting on October 30th, the yield may go even lower pretty fast. If you have lot of cash lying in money maket or savings accounts, you may start shopping around and put your money in CDs of various time frames depending on your future requirement.

Opportunity in Long Term Municipal Bonds

Municipal bond funds are attractive investment vehicles for high tax bracket investors. These bonds invest in debt issued by cities and other municipalities. They usually offer lower, steady returns, but are tax-free. However, in recent weeks, Muni bond prices have fallen pushing yields higher, as investors moved money into the safer securities, such as short-term Treasury bonds.

In the muni-bond market, the yield curve is usually steeper than for Treasury bonds or corporate debt. That's partly because cities and states like to borrow money for long periods, while mutual funds prefer to buy shorter-term muni bonds. That means there's lots of supply of longer-term muni bonds, so issuers have to offer higher yields to sell them. Some hedge funds use this to their advantage by buying the higher yielding, long-term muni bonds and then chopping up those into short-term munis called tender option bonds (TOB) and selling those to other investors with lower yields. So the hedge fund ends up making money on the difference between long-term and short-term muni yields. Such trends had led to flattening of the muni yield curve but the market turmoil in August originating from sub-prome mortgages again pushed the yield for long-term muni bond higher.

After sharp losses in August, most mutual funds based on municipal bonds remain down by 5% or more so far this year. These include the $4.6 billion Eaton Vance National Muni fund (EANAX, Friday's close : 11.20, +0.02), the $5 billion Oppenheimer Rochester National Muni fund (ORNAX, Froday's close: 11.65, +0.01, down about 8.5% this year), the Goldman Sachs High Yield Muni fund (GHYIX, Friday's close: 10.71, +0.02), the Nuveen High Yield Municipal fund (NHMAX, Friday's close: 21.34, +0.03).

This downturn has presented opportunities for individual investors. Some investors may now give a serious look at such funds to take advantage of the current high yield of longer-term muni bonds.