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CD rates: some history lessons

December 30, 2010

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

One of the difficulties with assessing the current environment for CD rates is that there is no precedent for it.

Even the best CD rates have never been this low before, so there are no examples from history to illustrate how long we can expect them to stay at this level. If nothing else, though, history can help underscore how unusual the current situation is--and that is enough to guide some decisions about CDs.

The key decision you face when choosing a CD is the length of the term--how long should you commit your money? CD rates are low now, but they were considered low two years ago and still came down further. If this is the trend, doesn't it make sense to lock in longer-term rates after all?

History suggests not. Today's interest rates on CDs aren't just low; they are low relative to current and historical inflation, and long CD rates are low relative to short rates. A look at some history on CD rates reinforces the message that today's CD buyer should stay short.

CD rates: 4 historical perspectives

Here are a few historical perspectives which suggest that now is a bad time to lock into a long-term CD:

  1. CD rates really are as low as they seem. CD rates have been low for so long that it would be understandable to start thinking of current levels as normal. History reminds us that they are nowhere near normal. According to Federal Reserve Data, annualized 1-month CD rates had never fallen below one percent before 2009. Historically, those rates have averaged 6.16 percent; as of October, 2010, they were at 0.24 percent.
  2. There is no spread over inflation. Historically, 1-month CD rates have given depositors an average edge of nearly 1.78 percent a year over inflation. As of October, however, 1-month CD rates were losing money to the prevailing inflation rate by 0.96 percent.
  3. Inflation isn't usually this kind. Not only are interest rates on CDs failing to beat inflation, but they are doing so at a time when inflation is unusually mild. According to the Bureau of Labor Statistics, inflation was at 1.2 percent for the 12 months ending in October of 2010. Since 1965, inflation has averaged 4.38 percent. In other words, a return to anything like normal inflation would be devastating to anyone locked into a CD right now.
  4. There is usually a greater reward for going long. Federal Reserve data only tracks 1-month, 3-month, and 6-month CD rates, so there is a limited ability to look at the spread between long and short CDs. However, using the spread between 6-month and 1-month CD rates as an indicator shows that normally 6-month rates have been 0.20 percent higher. As of October, 2010, they were only 0.11 percent higher, so there is an unusually small reward for locking into a longer-term CD.

All of this history underscores how unusual today's environment is, and how singularly unrewarding CD rates are as a result. Those are two good reasons to avoid long CD commitments. Instead consider other deposits such as money market accounts or savings account to help you earn interest on your money.

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