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CD Rates Are Heading in the Wrong Direction

Posted on the 28 March 2013 by Mdelp


CD rates are one of the main financial trends I follow because:

  • No one HAS to buy a CD. Unlike gasoline or food, my ability to earn a living or feed my family won’t change if I decide to buy or not buy a CD today or tomorrow.
  • All FDIC insured CDs are created equal so any difference in rates between a 6 month CD at one bank and a 6 month CD at another bank is due to other factors besides the underlying product.
  • 6 Month CD rates have historically tracked quite nicely the movement in other major data points such as the S&P 500 Stock Index, Retail and Food Service Sales, Case-Shiller Home Price Index, Consumer Revolving Debt Balances, Private Employment and New Orders for Durable Goods.
  • CD rates can be considered a type of “fear index”. If I’m afraid my employer is cutting staff or due to (insert latest geo-political drama here) I’m afraid my stock and bond investments might fall apart, I’m more likely to hold more cash and cash like investments such as CDs and thus accept a lower interest on my CD vs. when times are better.  
  • Banks use CDs as a way of attracting customers and their deposits.  One of the lessons I learned from watching how banks reacted during 2007-2009 was the more a particular bank needed deposits on the books the higher it was willing to paying on CDs over their competitors.

This chart shows the S&P 500 Stock Index (blue line, left side) and the average 6 Month CD Rate (red line, right side). The two lines historically trended very closely until March 2009.

FRED Graph

This chart shows how far apart 6 Month CD rates and the S&P 500 Index have diverged since then.  

FRED Graph

This same divergence can be seen in New Orders for Capital Goods (i.e. products that are expected to last longer than three years).

FRED Graph

And Retail and food Service Sales

FRED Graph

And Non-Farm Private Payrolls

FRED Graph

Part of this divergence trend can be explained by the Federal Reserve and their extremely low Federal Funds Rate which acts as a sort of pricing guide for CDs.

However, as this chart shows, there are been times when CD rates and the Federal Funds Rate are quite different.

FRED Graph

Even today, lists 6 Month CDs with interest rates from a low of 0.05% to a high of 0.88%.

Why I believe the CD Rates have moved so far apart from other economic data points has much more to do with how the public “feels” about the economy is doing rather than how the economy actually is improving.

In essence:

“Don’t bother me with facts. I know what I know.”

If you’re willing to in something that pays near zero interest for six months, you must believe that is a better investment than anything else otherwise you wouldn’t invest in it.   

Do you believe earning near zero interest is the best you can do?


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