Are Low Bank Rates the Result of a Treasury Bond Bubble?

If you've had to roll over a CD lately, you may have been shocked at how low interest rates on CDs have gotten. A contributing factor to the incredibly low-level bank rates is the Federal Reserve's artificially low interest rate rate policy. According to some experts, this policy has created a bubble in a variety of financial assets and commodities, including what are often considered the safest investments in the world--US Treasury bonds.

Interest Rates for CDs Continue to Shock

Whether you are rolling over long-term or short-term CDs, today's rates no doubt come as a bit of a shock. Anyone rolling over a CD more than a year old will be facing a precipitous drop in their CD rates. Even if you are rolling over a shorter-term CD from earlier this year, when rates were already low, today's CD rates may come as an unpleasant surprise. Six months ago it seemed interest rates on CDs couldn't possibly get any lower, but as anyone now faced with a rollover realizes, they have.

Fed Policy, Treasuries, and Bank Rates

It's important to understand that, as much discussion as there is about the Federal Reserve and interest rates, the Fed only controls a very narrow range of interest rates. Most market rates and publicly available bank rates are determined by a variety of other market factors. However, by sustaining an artificially low interest rate policy on its end, the Fed is having a spillover effect in other areas of the financial markets.

For example, with interest rates near zero at the short end of the yield curve, investors have moved out into longer-term Treasury securities. Higher demand for bonds drives interest rates lower, so as of late November, even 5-year Treasuries were barely above 2%. On top of the Fed's low interest rate policy, there is also demand for Treasuries from China. Bolstering the US dollar helps keep China's exports cheap in this country, so China has amassed nearly $800 billion in Treasury holdings. This added demand pushes Treasury rates even lower, and bank rates follow suit.

The irony is that the Fed's policy is also accused of driving up commodity prices, which could be inflationary. Low bank rates and rising inflation represent the worst of both worlds for depositors.

Managing Low Interest Rates

What to do in this situation? Perhaps the best approach is to take a page from the book of the old Brooklyn Dodgers manager Charlie Dressen, who is attributed with telling his team in times of trouble, "Just hold 'em, boys--I'll think of something." In other words, the best strategy may be to play for time and see if interest rates rise.

Specifically, here are three things you should be doing to cope with low CD rates.

• Keep an eye on inflation. Inflation creates both the downside of getting locked into low CD rates and the impetus for driving rates higher. Trends from recent months show that inflation is likely making a comeback.
• Stay flexible. As long as inflation remains on the rise, stay short-term with your CDs so you can roll over promptly as interest rates rise.
• Make the best of today's rates. Shop Money-Rates.com for the best rates available on CDs as well as other deposit accounts. You can't change the market, but you can do a little better for yourself.

Source:

Federal Reserve Statistical Release: Selected Interest Rates • Dec 07, 2009 • Federal Reserve: http://www.federalreserve.gov/releases/h15/current/h15.htm

Matthew Craft • Treasury Bubble • Nov 30, 2009 • Forbes.com: http://www.forbes.com/2009/11/30/bill-gross-treasury-fed-china-markets-bonds-economy.html?feed=rss_markets

 

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