CD Rates: How Are They Affected by the Strong Dollar/Weak Euro Situation?
June 23, 2010
| MoneyRates.com Senior Financial Analyst, CFA
June 2010 began with the euro reaching a four-year low against the US dollar. Since currencies and interest rates have more than a passing relationship with one another, the slide in the euro is worth noting by any depositor keeping an eye on bank rates. A reasonable understanding of bank rates may be especially important for people invested in CDs, since CD rates can represent a multi-year commitment.
The euro's weakness could have a short-term benefit for US depositors, but in the long run could become yet another factor keeping bank rates at extreme lows.
CD Rates: The Lay of the Land
As US bank depositors know all too well, recent movement in the value of the euro has taken place in an environment of low bank rates across the board. According to FDIC figures, 1-year CD rates were averaging just 0.76% at the beginning of June 2010. Even 5-year CD rates were barely over 2% at the beginning of June, but the inflation rate was running at 2.2% for the year ending April 30, 2010.
The question is, should you lock yourself into CD rates for such a long period when bank rates are uncommonly low--especially when their purchasing power is likely to be largely lost to inflation?
A Strengthening Dollar Suppresses Inflation
The pivotal role of inflation in determining the value of bank rates helps explain why depositors should sit up and take notice of changes in currencies. A strong domestic currency makes imports from overseas--and in this case, Europe--cheaper. Cheaper imports help keep a lid on inflation. From this point of view, the strength of the dollar relative to the euro is good news for those with funds in certificates of deposit.
Unfortunately, the inflation-fighting benefit of a strong dollar relative to the euro comes with some limitations and reservations and may not play out so well for bank rates in the long run.
Longer-Term Consequences for CD Rates
The flip side of cheap imports is that a low euro makes American goods and services less competitively priced in Europe. Last year, according to the US International Trade Commission, the US exported $220 billion worth of goods to the countries of the European Union--but imported $280 billion. If this trade imbalance grows, it could hold back the US economic recovery. This in turn would prolong the conditions that have led to such low bank rates. Indeed, the Federal Reserve would be more hesitant to raise interest rates for fear of exacerbating the imbalance between the dollar and the euro.
Also, the euro's weakness does not affect the dollar's competitiveness in Asia. The US imports more than twice as much from Asia as from Europe, and imports from China alone exceed imports from all of Europe. The Chinese currency floats against the dollar, but only within a fairly limited range--and if anything, pressure is on the Chinese government to raise, not lower, the value of their currency relative to the dollar. (As of late June 2010, the Chinese government has expressed more willingness to let their currency rise against the US dollar.)
The bottom line, then, is that the euro's weakness could have a short-term inflation-fighting benefit here in the US. However, that benefit is limited, and the economic weakness associated with the euro's decline could make low bank rates a more lasting condition.
What's a CD depositor to do? This discussion is about average CD rates, but keep in mind that interest rates on CDs differ from bank to bank. Comparing banking institutions is one way you can respond to these macroeconomic conditions. (For more on this, read Low CD Rates Mean Shopping for the Best Bank Rates Is More Important Than Ever.)
