Short Term, Long Term, CD Rates Defy Term Structure

Longer term CD rates should be higher than short term CD rates.  Investors generally accept a lower yield to have a shorter maturity or on the other hand expect a higher yield on the longer-term, less liquid CD.  This characterizes a fairly normal economic condition for most all interest bearing securities, since investors expect to recieve higher returns for giving up the access to their money for a longer period of time.

We are seeing some banks begin to offer higher rates on the shorter-term CDs then the longer term. CD rates are currently almost flat across all maturities out through five years. Therefore there appears to be no interest rate premium for giving up access to your money for a long time. 

A yield curve describes a relationship between short and long term interest rates for interest bearing securities.  Normally finance geeks look at a yield curve of US Treasury securities.  Technically US securities work best because of their quality and liquidity.  Interest rates on bank CDs would normally follow the change in Treasury yields. But, if we were to chart a yield curve of bank CDs we would have a flat yield curve.  If there is a connection between U.S. Treasury rates and CD rates, there should be a considerable drop in CD rates at least on short term maturities.  

A flat yield curve is normally a significant event that will generally impact most all debt instruments, investors that seek yields in this arena as well as consumers.  Most finance geeks would pay in depth attention to these rates so that they may adjust their portfolios accordingly.  The assumption being that rates are headed lower and that stretching for extra yield by extending the maturities of interest bearing assets such as bank CDs is a prudent choice.

The significance of the lack in spread between short and long term CD rates may be that the banking industry believes rates will continue on their way down.   Of course, the banking industry’s need to raise additional money through deposit growth could be the best explanation for our present CD rate environment.

In this market there is an opportunity to buy short term CDs since the CD rate is on these maturities is the same as the longer term CDs.   However, if CD rates are headed lower, it would be advantageous to invest in longer term CD rates and lock in the high rate for a longer period. The best advice is to stay informed on the current economic and interest rate environment and make an informed decision.  

This entry was posted on Sunday, November 2nd, 2008 at 4:34 pm 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.