Economic Policy and CD Rates

Two recurring economic policy issues were in the news in March 2010. Both of these issues have a potential impact on bank rates, and especially long-term CD rates.

The two issues are when the Federal Reserve should raise interest rates, and whether China should allow its currency to rise relative to the US dollar and other world currencies. These two issues may seem unrelated, but they have a number of things in common: they both represent attempts by central governments to control the economy, they both represent a reach for immediate benefits at the expense of future consequences, and they both deserve the attention of any depositor invested at today's low bank rates.

Interest Rate and Currency Issues

The following are the dilemmas represented by the interest rate and currency issues:

• The Federal Reserve lowered interest rates during the recession, which is a normal response--but in this case it took extraordinary measures to lower both short and long-term rates. Now with the economy growing and inflation starting to re-emerge, you might expect the Fed to back off and let rates rise a little. However, the Fed seems reluctant to do so just yet. With the job market yet to gain any momentum and the stock market acting skittish at any hint of higher interest rates, the Fed is keeping its foot on the monetary accelerator, even if it means having to deal with inflation down the road.
• The currency debate is all about trade. China keeps its currency low to make its exports competitive. That's not good for our trade balance, but it does help make things cheaper here. By pressuring China to raise its currency, US policy makers are signalling a preference for trade over low inflation.

Implications for CD Rates

Economic policy can seem so big-picture that it can be difficult to relate to more specific, real-world issues. However, these economic policy decisions have repercussions that extend to households throughout the country.

To look at these two issues from the viewpoint of a CD investor, you could easily get the impression that the US government doesn't have your interests foremost in mind. For example, it was one thing to keep interest rates artificially low when the economy was shrinking and the inflation rate had turned negative. Now, however, with the economy growing and inflation back to normal levels, bank rates are stuck below the inflation rate. When the Federal Reserve worries about the impact of raising interest rates, it is not giving a high priority to the people who could actually benefit from such a move.

The currency debate between the US and China also has implications for inflation. Getting China to hike its currency relative to the dollar would make US exports more competitive--and Chinese imports to this country more expensive. That would add inflationary pressure in the US, with a corresponding decrease in purchasing power for depositors.

These economic policy issues affect all bank rates, but they are especially important in relation to CD rates. After all, it is CD investors who have to consider how long to lock into today's bank rates, with the potential of being powerless later against a rise in inflation. With inflation reduction clearly a backburner issue for US economic policy makers these days, you might want to think twice about locking in CD rates for too long.

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