CD Rates' Inflation Hurdle Just Got Higher
May 21, 2010
Through the end of March 2010, the inflation rate reported by the US Bureau of Labor Statistics for the trailing 12-month period crept up to 2.3%. That's not a high rate of inflation, but it raised an important hurdle that most bank rates were already having trouble clearing.
People choose bank deposit products like CDs for safety--they want to preserve the value of their savings. Part of that is knowing that the money is secure, but another part is earning enough interest to protect against inflation. Over the past year, bank rates haven't kept up with this second requirement, and it appears now that they are falling even further behind.
CD Rates Across the Maturity Spectrum
Historically, CD rates have exceeded inflation, but that is not the case now. No matter where you look along the maturity spectrum, from short-term CDs to long-term CDs, average rates trail the prevailing inflation rate of 2.3%.
According to Federal Deposit Insurance Corporation (FDIC) figures as of mid-April 2010, here are how average CD rates look, from short-term to long-term:
- 1-month CD: 0.20%
- 1-year CD: 0.78%
- 3-year CD: 1.57%
- 5-year CD: 2.11%
As is usually the case, there is some gain in rates as you move from short-term commitments to longer-term ones, but what makes the current situation different from the norm is that none of these rates is sufficient to beat the prevailing rate of inflation.
Inflation Results and Expectations
A fundamental problem with comparing CD rates with inflation at any one point in time is that the inflation rate is based on what happened in the past, whereas CD rates represent a commitment into the future. Strictly speaking, CD rates shouldn't be compared with the trailing months' inflation results but rather measured against expectations about future inflation--specifically, the expected inflation rate through the term of the CD.
Unfortunately, current CD rates fare even worse if you consider reasonable expectations for inflation in the months and years ahead. First of all, the trailing 12-month inflation rate of 2.3% is below average historically, which means it has to rise to return to historical norms. Moreover, in a transition from economic recession to expansion, one would normally expect some strengthening of inflation.
Implications for CD Shoppers
So CD rates are losing the battle to inflation, and one might reasonably expect this battle to get even tougher going forward. What's a CD shopper to do? Here are three keys:
- Keep your commitments short. It may seem tempting to go long with a multi-year CD and grab the highest rate so that current inflation takes a smaller bite out of your yield. However, the inflation environment suggests that bank rates are unnaturally low, so it could pay to stay flexible in order to catch rates as they rise. If the inflation rate rises more from here and drives up interest rates on CDs across the board, having locked into a long-term CD now could prove to be a big mistake.
- Shop for the best CD rates. Whatever length of CD you choose, shop actively for the best available rate. MoneyRates.com is finding CD rates that are significantly higher than the national averages at every point on the maturity spectrum.
- Check back often. With CD rates trailing inflation and with the economy in transition, this is both an unusual and a dynamic situation. MoneyRates.com posts new rates continually, so use this resource to make your decisions based on the most current information.
