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What Does Deflation Mean for Savings and CD Rates?

April 09, 2009

By Clark Schultz | Money Rates Columnist

The inflation rate in the United States has just barely crept along in positive territory in 2009. The Bureau of Labor Statistics reports an inflation rate of 0.03% in January and 0.24% in February, but economists are warning that the chance of deflation (negative CPI) later this year exists.  Deflation is bad for Americans because it can cause a downward spiral in unemployment and wages, bringing more misery to a struggling economy. The Federal Reserve, citing the threat of deflation in recently released minutes of their latest meeting, has committed to buy up to $1.25 trillion in long-term assets to shore up the economy and to try and head off deflation. Even with the Fed pulling out all the stops, the risk of deflation is persistent. What does this mean for savings rates and CD rates?
 
CD Rates
In a protracted period of deflation short-term interest rates will stay low or fall even further.  The Fed will not raise interest rates with the economy shrinking and prices falling. This means that locking-in rates on CDs with terms of 90-days, 6-months, or 1-year may be a good idea. Longer-term CD rates are a bit trickier to predict. Banks typically will change the rates on their 2-year, 3-year, 4-year, and 5-year CDs based upon on what Treasury securities with corresponding maturity dates are yielding. The Fed does not directly control Treasury yields, thus longer-term CD rates can jump higher based on economic, political news, or even banking news. A CD investor considering locking-in a rate has to consider: Is this is a good deal because CD rates are likely to stay low? Or is it a bad deal because rates may increase down the road? Financial advisors also caution that an investor’s potential need for cash should also be evaluated before locking-in on a particular CD term

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