Savings Account Rates Actually Look Stronger As Yield Curve Steepens

The yield curve on bonds steepened in early December, as short-term rates fell and long-term rates rose. Counterintuitively, this may have strengthened the attractiveness of savings account rates compared to CD rates.

If that seems like a through-the-looking-glass interpretation, it's because of the generally strange environment bank rates are in right now.

Yield Curves and Interest Rate Expectations

The yield curve is a line that would be formed by plotting the current interest rates, or yields, on bonds of different term lengths, from short-term to long-term bonds. It is called a curve simply because plotting these yields generally does not form a straight line. The curve can actually take any shape, but in general, yield curves tend to be upward-sloping. All this means is that yields on long bonds are usually higher than yields on short-term securities. This makes sense, because the longer you commit your money, the more risk you are taking--and therefore you deserve to be paid a higher interest rate.

However, in addition to demonstrating this normal relationship between yields, risk, and time, yield curves can also tell us something about market expectations for the future. For example, a downward-sloping yield curve--which is rare--suggests a market expectation that interest rates will be lower in the future than they are now. On the other hand, if an upward-sloping yield curve steepens (i.e., if the long yields rise relative to the short-term yields), it implies a growing consensus that interest rates will rise in the future.

Recent Yield Curve Changes and Bank Rate Implications

This latter scenario is what took place in early December 2009. In the space of a week, 30-year Treasury bond yields rose by 13 basis points, or 0.13%. At the same time, 3-month Treasury yields actually declined by a point. By December 9, 2009, the yield on a 3-month Treasury was down to 0.01% while 30-year Treasuries were yielding 4.38%.

So what does this mean for bank rates? This is where the counterintuitive part comes in. Ordinarily, seeing short-term rates very low relative to longer-term rates would lead you to bypass savings account rates in favor of longer-term CD rates. However, two factors about the current environment suggest you might want to do the opposite.

First of all, while bank rates are generally very low, savings account rates are not nearly as low as short-term Treasury rates. As of early December, the average savings account rate posted on Money-Rates.com was 1.23%, with several banks offering higher rates. Banks know better than to bother offering customer accounts that yield virtually nothing. So current savings account rates represent a better deal than you might expect with such a steep, upward-sloping yield curve. Moreover, putting your deposits in savings accounts preserves flexibility as the economy recovers.

Second, that steep yield curve represents the bond market's expectation that interest rates will rise in the future. There is plenty of logic on the side of this argument--a strengthening economy, rising inflation, and the fact that interest rates have been kept this low with help from an extraordinary amount of government intervention--intervention that will soon be winding down. CD rates, however, have yet to rise sufficiently to reflect this expectation of rising interest rates.

The bottom line for bank rates is that it doesn't make sense to move out to longer instruments until rates have risen from current levels. In other words, don't bother climbing the yield curve until CD rates make it worth the climb.

Source:

US Treasury Bond Rates • Yahoo! Finance: http://finance.yahoo.com/bonds