Stability of CD Rates Not All It's Cracked Up to Be

Bank rates began 2010 in the same holding pattern that dominated 2009. Take 1-month CD rates. If you've had to roll over a CD any time in the past year, you've probably been dismayed to find short-term CD rates below 0.50% and longer-term CD rates not much higher. If you were patient and waited to see if they'd get better, you're probably still waiting.

Normally, in financial discussions, stability is a good thing. However, the stability of bank rates has been anything but good for depositors over the past year. Stability of the very low yields has been damaging for the obvious reason that depositors earn less interest--but there's also a less obvious and more ominous reason why stable rates are a bad sign for those with significant funds in CDs.

What's Obviously Wrong with CD Rates

Bank deposits may be safe, but the earning value of those deposits has been decimated by the recession and the financial crisis. A 1-month CD has lost 97% of the income-generating power it had when the recession began.

According to data from the Federal Reserve, average 1-month CD rates dropped below 1% in January 2009 and have since been below 0.50% since then. Rates have been so low that those of you who had been waiting for a better deal on CD rates--by keeping the money liquid in savings accounts or money market accounts--haven't been much worse off than those who locked in too soon with a low-yielding CD. Believe it or not, that's the good news.

The Hidden Problem with CD Rates

The bad news is that, while CD rates have been stable, inflation has not. After bottoming out at -1.9% last July, year-over-year inflation has since turned positive and climbed above 2%. Against this changing inflation backdrop, stable CD rates aren't really that stable after all.

When inflation was at -1.9% last July, it could be argued that 1-month CD rates at 0.27% (their July average) were not a bad deal. Effectively, they were offering a 2% return above the rate of inflation; in purchasing power terms, this would be the same as a 5% CD rate at a more normal 3% rate of inflation.

Now, however, inflation has risen to surpass most bank rates currently available. This means depositors are losing purchasing power. Besides making conditions more burdensome to depositors, this juxtaposition of stable bank rates and rising inflation is unusual. Normally one would expect bank rates to rise in that situation. In actual fact, they've begun to fall.

A combination of stimulative monetary policies and extreme caution on the part of banks has probably been the reason why CD rates--along with savings account rates and money market account rates--haven't followed inflation higher. This is the biggest problem with CD rates now.

In this grim situation, what can you do? Two courses of action you can take are:

1. Keep your deposits short-term. Given that the rising inflation/falling bank rate situation is an anomaly, it might be wise to wait for things to return to normal rather than lock into a long-term CD at current rates.
2. Shop aggressively on MoneyRates.com. While CD rates on average have been stable, there are meaningful differences among the offerings of different banks. More than ever, this is no time to settle for average rates.

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