Thoughts on Current CD Rates
Right now I’m dealing with a lot of irrational behavior in the CD market. More and more people are closing out their accounts here because they are being lured away by higher rates at other institutions. This is not unusual, but at least one group of these rate shoppers are going to end up missing out on a lot of interest that they could have had if they had taken a lower rate for a little while.
Let me explain myself.
There are two groups of bankers paying high rates right now. One camp pays them because they have to do it. They’re on the verge of going out of business and have to pay high rates in order for you to leave your money there. As long as you’re FDIC insured, you should take advantage of these poor souls.
The group that I want to deal with in this post is the banker who pays high rates because he wants to do so, not because he is desperate to keep your money.
This group is exceedingly smart, forward thinking, and low-risk taking. He’s paying rates on short term CD’s at current market rates. That is, for CD’s with around 30-days to 2 year maturities, he’s paying somewhere between .5% to a little less than 2%, respectively. That’s not how he’s being smart though.
What the smart banker is doing is locking in long term CD money now in anticipation of substantially higher rates coming in the future. He’s paying around 4% (which by the way isn’t really all that high of a rate compared to rates over the last 20+ years) on 5 year CD’s. Right now, that CD is losing him money, but over time, he’ll make a killing on it.
Here’s why:
With the Federal Reserve and the Federal Government already having promised, guaranteed, or directly put 11 trillion dollars into the economy, there is going to be inflation. You cannot put that amount of money into our economy without devaluing our currency, i.e. causing substantial inflation.
(Read Fed. Charman Bernanke’s latest comments on inflation here)
If words like inflation, devaluation, the mirage of the Federal Reserve, etc., don’t mean much to you, let’s put it in terms of something everybody understands: gas.
Everyone needs it, everyone wants it, and you have to use it almost every day. Now, let’s say everyone had to drive as much as they do now with the car that they have right now, BUT there was only enough gas on earth for everyone to have three gallons per month. The price of gas would be unbelievably high, right? Gas would be VERY valuable.
Alright, now take that same scenario and let the oil countries produce so much for everyone to have one thousand gallons a month. The price would be extremely low right? It wouldn’t be nearly as valuable. That second scenario is what is going to happen to the value of our dollar over time because there are just so many dollars available right now.
When inflation hits, and it will, interest rates will naturally go up in line with how bad that inflation gets. This means that bankers will have to pay you higher rates on your CD’s. So right now, the smart banker is using his forsight and knowledge to pretend to be paying people a “high” interest rate on 5 year CD’s, all the while knowing that you’re being a fool for falling for his little trap.
My point is: Before you just go after the highest rate, look at the longer term implications. If something seems too good to be true, it probably is. Bankers paying high rates on short term money are probably going out of business soon. Those paying “higher” rates on long term money that locks you into a very long holding period are probably taking advantage of your ignorance about inflation.
Remember, inflation runs somewhere between 2% and 3% per year in good years. We’re about to enter a period of high inflation (think something similar to the late 1970’s and the Nixon/Carter years). Do you really think that 4% on a 5 year CD is a great rate in light of the fact that just 12 months ago you were getting 5.35% on 1 and 2 year CD’s? Do you really think that if prices at the grocery store are rising at 5-10% per year that you’ll be happy about basically losing money on your CD? If you’re fine with all that, then by all means, get that 4% CD. If that scenario scares you, put your money in something much shorter term and settle for the lower rates in anticipation of being able to get a much higher, inflation-adjusted rate in the fairly near future.
If you don’t believe me when I say 4% is a historically very low interest rate, check out what rates on 6-month CD’s have done over time here. Keep in mind these CD’s have terms 4.5 years shorter than what you’re locking in if you take that 4%, 5 year CD.
(For all you who care about political correctness, insert “she” in the smart banker references wherever you deem appropriate.)
Interesting argument, Raymond. I do wonder, however, why other enterprising bankers (such as yourself, perhaps?) are not willing to compete for these profits from saver naïvete by offering even higher long-term CD rates? Is the market for long-term CDs somehow not competitive?
Brief walk through history to provide a good answer:
There used to be much more emphasis on Savings and Loans being distinct from Commercial Banks. S&L’s typically funded mortgage obligations with terms of 15-30 years with deposits that were typically longer-maturities. This allowed them to match maturities and stabalize net interest margin more effectively. The most crucial reason for this long term funding on the deposit side was so that there was no liquidity crisis- i.e. they didn’t have very short term deposits funding very long term mortgages.
Now, what “commercial bankers” typically do is more short term funding on the deposit side to fund much more short term loans. When you start getting out to three and five years on the deposit side, you start having a very very difficult time managing your net interest margin effectively, since your loans generally have maturities far shorter than that. For any banker with half a brain, though, as your comment expressly states, this is the exact time to bet some of your capital on a long term inflation hedge. In banking that hedge is absolutely straightforward- you lock in long term deposits and allow your assets (loans) to reprice much more quickly. This maximizes the spread.
To answer your question more directly though, the reason why a lot of (community) bankers won’t take advantage of this is because they simply are too conservative or not sophisticated enough to get out into these longer term deposit maturities. The treasury yields pretty much dictate what the yield curve is, so it’s not hard to price these things at market rates, but it’s the risk involved in locking yourself in for that long without being able to project what your assets will look like that scares people.
So just what is the effect on CD.s from Treasury notes/bills rates? If the treasury stuff has a high rate does that mean CD rates are low, or does it mean they go higher?
I’m not sure what the deal is here, cause I heard if one is higher the other is lower and visa vrsa.
That’s definitely a great question. The first and simplest answer is that, for the most part, all interest rates on all debt tend to move in the same direction. A great analogy I’ve used in the past is to think about the interest rate market as a traffic jam. For the most part, if you’re stuck in traffic, switching lanes and trying to move up faster than everyone else is almost always useless. All the cars in the traffic jam are going to eventually move at about the same rate of speed.
To speak directly to your question concerning the Treasuries-
Treasuries are an important part of the world debt market. This is primarily because Treasuries, even now, are considered “risk free” meaning you are 100% guaranteed to get your money plus the stated interest rate at the end of the term. As long as they are considered risk free, Treasury interest rates should always be lower than any debt you can buy. Keep in mind, CD’s are actually a form of debt for banks. You’re lending the bank the money. So basically, if Treasury interest rates are going up, CD rates will tend to follow that trend. If Treasury interest rates are going down, CD rates will also follow that trend.
I think you might be a little confused on some of the language commentators use (and misuse) when speaking about Treasuries. For all bonds, including Treasuries, there is a face value, a bond price, and a coupon price. The face value is the amount of money you will receive at the end of the term of the bond. The bond price is set by the market, and it might be above or below the face value, depending on what interest rates have done since the bond was first created. The coupon price is the interest rate that you are paid until the maturity of the bond. I’ll spare you some time with my own explanation and point you to here to check out the mathmatical explanation. Basically, when bond prices rise, interest rates on those bonds fall. When bond prices fall, interest rates on those bonds rise. I think this might be what you have in mind when you talk about the inverse relationship.
To sum it up: If Treasury interest rates rise, CD interest rates will also rise. If Treasury interest rates fall, CD interest rates will also fall. The key is to hone in on what the interest rates are, which can be very confusing to follow at times.
OK thanks for the long drill Admin, I think your right about the bonds terminology is what probably got me mixed up on all this stuff.
I seen times like this before, with rates well below what they were prior, I managed to ride it through than and guess I’ll do the same now, from what I experienced in the past, when this snail starts back up, there will be a brief time to lock in long term again, as it will also again slow as usual.
The way I see things I think Ben and the boys are doin their damnedest to “make” anybody with any savings spend it by making it so damned hard to save it now, while BS’ing everybody into believing they’re getting some sort of great “non-Inflation” price for what they wana sell you, yeah right. My bills haven’t fallen per the inflation, my food cost and energy costs are just as high or higher than last year. I don’t buy 10 tons of steel a week which may be what they are talkin bout, to dump in the back yard.
I’ll truck along as I always have, its worked for me, but it is hard when a good rate CD comes due now and swallow when the bank grins at you and asks you what you wana do now.
After looking into this more, I see now where the fed won’t let the FDIC go broke, it will just “bail” them out as all the other broke items. Even the stock pusher clowns on CNBC incl the one with the noise making machine say so. Only thing I guess would be next question though is if a “big” bank was to go, just how long would the FDIC decide it wanted to take to pay the “insured” accounts? My guess is a while. So I use 3 different banks and maybe even a 4th to spread things around as not all banks in my area are 5 star rated, they are 3 to 5. But I figure they won’t ALL go at the same time. ( I hope ) No reason to keep it in cash cause if the situation gets as bad as some think, the paper won’t be worth shit either, and since you don’t have a Ft Knox you probably won’t have that much gold around either, besides a lb of meat is edible, a lb of gold just sits there, if I had the meat why would I want the gold?
So relax, keep “some” cash available but keep the rest in the bank, you’ll get it back some time lol