A low interest rate environment is not necessarily a bad time to buy CDs. As we've seen over the past year, deflation--a general condition of falling prices--can make seemingly modest CD rates worth more than meets the eye. However, there is one measure that suggests that today's interest rates on CDs are not all they should be.
Comparing 1-month, 3-month, and 6-month CD rates with 1-month, 3-month, and 6-month Treasury securities shows that CD rates are below where the marketplace suggests they should be.
The Spread Between CD Rates and Treasury Rates
What should we expect from the relationship between CDs and US Treasury securities of comparable maturities? The US Federal Reserve makes past data on 1-month, 3-month, and 6-month CD rates available, making it possible to compare these with US Treasury yields for corresponding maturities.
What this comparison tells us is that CDs generally yield about 40 basis points more than Treasuries. The average spread historically has been 43 basis points at the 1-month maturity, 45 basis point at the 3-month maturity, and 35 basis points at the 6-month maturity.
It makes sense that CDs should offer a little more interest than Treasuries. CDs are not very liquid, and US Treasuries are considered the safest securities in the world. So, some premium for CDs is to be expected, and history gives us an idea of how big that premium generally is.
Today, the premiums for CD rates over Treasury yields are 16 basis points at 1 month, 17 basis points at 3 months, and 15 basis points at 6 months. This suggests that CD rates, relative to freely-traded interest rates, are lower than they should be. On top of that, the low level of interest rates in general, and the fact that the economy is starting to perk up, suggest that interest rates are more likely to rise at this point than to fall. Assuming that freely-traded Treasury rates react more quickly than bank CD rates, those spreads could get even thinner in the near future.
What You Should Do in This CD Rate Environment
Comparing the present with historic spreads between CD rates and US Treasuries suggests that CD rates do not represent a particularly attractive proposition right now. Here are three things you can do about that:
- Keep maturities short. The low spreads suggest that CD rates are due for a rise. If this is the case, you'll want to keep CD maturities short so you won't have to wait long before you can reinvest at higher rates.
- Seek alternatives to CDs. Currently, some savings accounts listed on money-rates.com are offering yields comparable, or better, than short-term CDs. With this being the case, why lock up your money?
- Shop for the best CD rates. The average CD rates listed on money-rates.com are significantly higher than the national averages reported by the Federal Reserve, so whether you choose a savings account or CD at this point, be sure to shop around for the best rates available.
With the economy apparently beginning to rebound, Treasury rates may be subject to sudden changes, making the spread between CD rates and Treasuries an indicator worth revisiting periodically.
Federal Reserve: https://www.federalreserve.gov/