Ask Money

Money market mutual funds

Chris Farrell Apr 29, 2011

Question: What impact will the end of QE2 and or the bumping against the “debt limit” have on money market funds? Art, Webster, WI

Answer: Interest rates are likely to rise under both scenarios. But the impact of these two events would be very different, from benign (QE2) to catastrophic (debt ceiling). And I think the interest rate moves would be minimal with and fearsome if the debt ceiling isn’t raised.

QE2 is shorthand for Quantitative Easing 2. When the economy was faltering last year the Fed embarked on a $600 billion bond buying spree to bring down long term interest rates. Lower interest rates would help support the economy and boost the stock market.

The program is slated to come to a close in June and during his historic press conference earlier in the week Federal Reserve Board chairman Ben Bernanke reiterated that it will end on time. The main effect of QE2’s demise should be on long-term interest rates. I expect short-term rates to rise a bit, too, reflecting both an improving economy and a shift toward a more conservative monetary policy by the Fed. I also don’t expect much of an upward move in interest from the end of QE2.

In sharp contrast, I think interest rates will soar if Congress fails to hike the debt ceiling and global investors start worrying about the increasing risk that the U.S. government debt could default on its debt. It would be an economic disaster made in Washington, not in the economy or the markets.

The consensus on Wall Street is that rates would shoot up, but no one really knows how high or for how long. We would be in unknown territory since the U.S. government has always made good on its debts ever since Alexander Hamilton, the first Treasury Secretary, established the nation’s good public credit.

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