The Yield Curve Steepens--But in the Wrong Area for CD Rates

In the absence of any significant movement in CD rates themselves, where should a rate-trend spotter look for clues about future movements? The yield curve of the US Treasury bond market can offer hints about where the market thinks rates are headed--including whether consumers should be looking at short-term or long-term CDs.

Bond market changes since the end of 2009 suggest that CD rates may take longer to rise, so CD shoppers have less attractive options in 1-month to 5-year term range.

Short-Term Spreads are Razor Thin

Let's first look at the short-term end of the spectrum. Rates for 1-month and 6-month terms barely differ in both CDs and Treasury bills. In fact, spreads between 6-month and 1-month CD rates in mid-March 2010 are only 0.14%, and spreads between 6-month and 1-month Treasury yields are a mere 0.09%. In other words, you don't get paid a much higher interest rate for locking up your money an extra 5 months.

Perhaps even more discouraging, that Treasury yield spread has narrowed since the beginning of 2010. At the end of 2009, it was at 0.16%, so falling to 0.09% means it has dropped almost in half. This narrowing of the spread suggests that CD rates may also offer less reward for longer maturities in the near future.

Treasury Spreads Widen--But for Maturities Greater Than Five Years

As would normally be expected, looking at larger differences in maturity terms produces wider spreads in interest rates. For instance, the spread between 1-month and 5-year Treasuries is 2.24%. Moving out from 5-year to 30-year Treasuries produces another 2.29% in yield spread. This pattern opens up some possibilities for consumers. There are significantly higher yields to be had in return for locking your money up for periods of years.

Unfortunately, even these spreads are moving against CD buyers. The spread between 1-month and 5-year Treasuries has also narrowed since year-end, from 2.65% to 2.24%. Meanwhile, the spread between 5-year and 30-year Treasuries has widened, from 1.94% to 2.29%. What this means is that spreads are widening in maturity terms generally beyond the length of most CDs--that is, beyond five years.

An Imperfect Look Into the Future

Looking at Treasury yields can be a glimpse into the future of CD rates, but it is an imperfect glimpse. For one thing, Treasury yields are a reflection of where the market thinks interest rates are going, but the market isn't always right. For another thing, banks can be slow to react to changes in market rates.

As an example of the latter, even though spreads between 1-month and 6-month Treasuries had already narrowed to 0.16% by the end of 2008, the spread on corresponding CD rates was still 1.31%. This created an opportunity for CD investors to do better by moving from short to intermediate maturities in the first half of 2009 (an opportunity that was described in MoneyRates.com almost a year ago).

That opportunity is gone, but when CD rates start to rise again, it will create new opportunities. CD rates are likely to rise by different amounts at different maturities, and some banks will react more aggressively than others. You'll want to keep an eye on MoneyRates.com to see where the advantages lie.

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