Short Term Interest Rate Profile

The 91-day T-Bill or "risk free rate" now trades between 0.00 -
0.25%. Money market funds have recently settled down at 1.75%
but yields have been in a downtrend. Despite the Fed's ZIRP
regimen, money markets have returned 5 - 6% over the past
6 months in real terms, as the CPI has experienced 4.5% deflation.
So, holders of short term quality debt have yet to be suckered.

Low short rates are warranted by the weakest economic conditions
in the post WW2 era. For example, the ISM index for manufact-
uring stands at 35.6, nearly 20 full ponts below the 55 level when
the Fed normally raises rates.

My long term regression (100 +yrs) model for the T-Bill yield
has an alpha of 1.7%, meaning that the bill should yield 1.7% at
zero 12 month inflation. The Fed, worried as it is about the
economy, has zeroed out the yield. Indeed, the real yield for
the past 6 mos. is over 4.5%.

Under normal circumstances of economic expansion and a
moderate 3% inflation rate, the Bill should yield about 4.7 - 5.0%.
This gives you a good quantitative benchmark to see how far the
Bill is below the long term capital market line. Once an
economic recovery begins, the Fed will move short rates up
much closer to the "normal" level.

So long as there is deflation in the system, many players will not feel
that pressured to pick up yield, as the Bill enhances the purchasing
power of their funds without credit risk.

In a deflationary environment, a meaningful real yield will tend to
suppress consumption and business investment as time wears on.
For now, consumers, facing bad housing, stock and job markets are
struggling to regain liquidity and build a cushion in a difficult
environment. As we head into the seasonally strong period for
housing this spring, it will be interesting to see whether liquidity
hoarding psychology will prevail in a market where affordability
has made a dramatic comeback.

More broadly, I do not know of a satisfactory rule to forecast
liquid savings, but I think it is ok to assume that when the
purchasing power of savings is rising, the personal savings rate
will tend to move back up to a longer term norm.