Bank Rates Behave Like US Treasuries, With Some Important Exceptions

CD Rates and Treasuries: Beyond Apples and Oranges

The market for US Treasury bills, notes, and bonds are a useful indicator of what to expect from bank rates in the near future. At first glance, bank rates and Treasury yields might seem like comparing apples and oranges: Treasuries are freely traded, typically in very large amounts, whereas bank rates are set privately and are often offered to relatively small depositors. However, watching Treasury rates can teach us something about bank rates.

Take 6-month CD rates. How similar are they to 6-month Treasury rates? You can sell a Treasury at any time before maturity, whereas you would pay a penalty to get out of the CD. However, if interest rates rise while you're holding a Treasury and you sell before the maturity date, you lose some principal--a form of economic penalty.

If, on the other hand, rates fall after you purchase a Treasury, you benefit from a rise in prices by selling early. The bank might be willing to let you out of the CD without penalty if rates had fallen after you funded the account, since doing so would be to their benefit, but there would be no advantage to you in doing that. In that particular scenario, Treasuries have an edge over CDs. Otherwise, they both represent a way of obtaining a given interest rate for a 6-month period, and both are backed by the US government (assuming the CD is below the FDIC insurance limit).

CD Rates and Treasury Rates: A Historical View

Balancing the similarities and differences of the two, how much do CD rates behave like Treasury yields?

Looking at monthly Federal Reserve data for both, available back to January 1982, the answer is that 6-month CDs and 6-month Treasuries are usually pretty similar. On average, 6-month CD rates have been 0.35% higher than 6-month Treasury rates. Six-month CD rates have been higher than 6-month Treasury rates 98% of the time, and 94% of the time they have been within 1% of 6-month Treasury rates.

All of this confirms the value of using Treasury rates as an indicator of what to expect from bank rates. They behave similarly on the whole, with banks usually offering a slight premium over Treasuries.

There is one significant anomaly, however. Never had 6-month CD rates been more than 1% above Treasury rates as often as they were in the months leading up to last year's banking crisis. Moreover, never before had those spreads exceeded 2%, as they did when they crossed the 2% mark in September 2008 and the 3% mark in October 2008. Even when they diverged, the relationship between CD rates and Treasuries was worth watching--this behavior suggests that banks were so desperate to attract capital in those months that they actually raised CD rates even while market rates were falling.

A Key Difference

Aside from that one-time anomaly, there is an important difference between CD rates and Treasury rates. CD rates are not set by a publicly traded market and thus can vary significantly from one institution to another. While the recent national average for a 6-month CD rate was just 0.36%, the average listed on money-rates.com was 1.36%. There were even a number of 6-month CDs on money-rates.com offering more than 1.5%. Conclusion: even in a low-rate environment, when it comes to CDs, it pays to shop around.

Source:

Federal Reserve Data Download • Federal reserve: http://https://www.federalreserve.gov/datadownload/Download.aspx?rel=H15&series=cd96ea93d92e94ff0ee19a2699cd688d&filetype=csv&label=include&layout=seriescolumn&from=01/01/1963&to=09/30/2009