Credit Markets Improve, CD Rates May Drop

The rates on banks lending to banks have been coming down measurably worldwide as central banks efforts to ease credit constraints are starting to show results. World banks have been cutting interest rates and pouring funds to their economies and financial system to increase lending activities and avoid a banking meltdown. The Federal Reserve’s action on interest rates helped to improve the fed funds rates and lending activities between U.S. banks. The central bank efforts of Europe have contributed to bringing down LIBOR rates to the pre-chaotic levels of October.

The U.S. economy and most world economies unfortunately are not showing any signs of improvement. The signs of recession are everywhere. Manufacturing is off. Housing is a continued problem in the U.S. Housing in Europe is problematic and we are waiting to see the impact in Asia. Auto sales are putting the car manufacturers in a distressing position. Retailers are forever hopeful but most economists are preparing for one of the worst retail holiday sales in at least 15 years. Clearly, the retail sales component of GDP is going to $#@. 2/3rds of GDP is going in the wrong direction, a crucial factor that can not be taken lightly. It is hard to believe the path of economic contraction we are heading down is going to change direction within the next 6 months. Economics 101 taught us that economic contractions lead to lower interest rates.

Even with the infusion of government funds into the banks, these banks are certainly not going to run out and loan funds either recklessly or without the added caution required by the impending recession. The bad news for the economy will linger, credit markets will remain extraordinary tight. Individuals and businesses are going to have a harder time getting loans in coming years. Any meaningful bank lending is a potential risk for future loan losses for those banks. A perpetual cycle that keeps credit limited and economic expansion contained.

The banks will still need to find other sources of capital to expand and increase profits. One way they can still raise some money is through the issuance of CDs. Bank interest rates are reflecting the liquidity needs they still have. With fed funds rates down and the whole Treasury yield curve less than the highest one year and five year CD rates, this is indication that banks are still aggressively seeking consumer deposits. For the past 5 months, consumers have been shopping bank CD rates and increasing their holdings in bank CDs as well as money market accounts.

As the number of banks that are being assisted by the Treasury’s TARP program expands, the aggressive need for depositor funds may wane. It is indeed odd that the prime rate has been reduced to 4.00% at some of the major U.S. banks such as Bank of America, JPMorgan Chase and Wells Fargo yet a depositor can receive a 5.00% rate on a five year certificate of deposit. Many lending institutions use the prime rate as a benchmark for the rate on loans for businesses and consumes including credit cards and home loans. The spread between the fed funds borrowing rate, the base lending rate or prime rate and the interest rates used to attract depositors will eventually have to come to better association. Perhaps, the days of increasing certificate of deposit yields may be ending. If CD rates head lower it will bring down that cost of funds dynamic for the banks. The pressure is certainly in the direction of lower interest rates for bank CDs and money market accounts.

This entry was posted on Wednesday, November 5th, 2008 at 11:31 am and is filed under Money Rates. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.