Dramatic Changes Merit a Fresh Look at Long-Term CD Rates

With bank rates generally low, the prevailing logic over the past several months has been to shy away from longer-term CDs. After all, why lock into multi-year CD rates at what may prove to be an historical low point? However, recent dramatic changes in the bond market yield curve recently may signal a reason to take a fresh look at longer-term CDs.

December 2009: a Turning Point for Bank Rates?

As the largest publicly traded market for interest rates, the Treasury bond market is something of a canary in the coal mine for watchers of money rates. Frankly, throughout most of 2009, the canary pretty much just died. Short-term Treasury rates--which have the most in common with CD rates, savings account interest rates, and money market account rates--just got lower and lower. One-month Treasuries ended 2009 with a yield of just 0.04%.

However, interest rates can behave differently at different points on the yield curve--that is, for securities of different durations. During December 2009, 5-year Treasuries rose from an annual yield of 2.01% to 2.69%. That's a fairly dramatic increase in just one month, especially relative to the meager level of interest rates overall. At the same time, 1-month Treasury rates continued to fall slightly. As a result, the spread in yields between 5-year and 1-month Treasuries grew from 1.93% to 2.65%. In financial parlance, this widening in yield spreads meant that the yield curve got steeper.

How the Yield Curve May Change CD Rates

This movement in 5-year Treasuries (and longer-term Treasuries in general) might be a bellwether for the eventual direction of bank rates across the board, but if the steepening of the yield curve is any indication, it may have the greatest effect on longer-term CD rates. If spreads between long and short Treasuries grow, why not the spread between long- and short-term CDs?

Committing to any fixed rate of interest for a longer time period carries certain risks, most notably the risk that you could miss out on further rises in interest rates, and the risk that unexpected inflation could erode the value of your deposits while your money is locked away. However, the higher long-term CD rates get relative to short-term CD rates, the more you are being compensated for these risks.

Starting the Year on Money-Rates.com

Looking at CDs on Money-Rates.com, it seemed that as of the first week of 2010, CD rates did not yet fully reflect the steepening of the bond market yield curve. The best 1-month CD rates were up around 1%, while the best 5-year rates were at 3.25%. As you would expect, this represents a clear advantage for 5-year CD rates--but the spread between 5-year and 1-month rates was 2.25%. This was wider than the equivalent spread in the Treasury market at the beginning of December, but smaller than the Treasury spread as of the end of December.

The sharp rise in the yields of intermediate and longer-term Treasury bonds during December 2009 may mean that longer-term CD rates will start to get more attractive relative to shorter-term CD rates in the weeks ahead. It also means that all bank rates--for both short-term and long-term vehicles--all bear close watching. A change for the better may be in the works.

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