The concluding point of our CD rate summary for the week ending August 7, 2009 was an examination of the competing camps on the future direction of CD rates and interest rates. 

This past month most interest rates moved lower in nearly all categories of rates.  Bank CD rates moved lower across all terms from 6 month CD rates to 5 year CD rates.  The average of the best six month CD rates has fallen 15 basis points or 15/100 of a percent since the first week of July.  One year CD rates have shrunk by 19 basis points in the same time frame.  And the average for the best five year CD rates is down 22 basis points. 

Auto loan rates moved noticeably lower as well since the start of July this year.  Based on the data presented at, the rate on a new a car loan with a five year term is now at 5.49%, down 41 basis points in the past five weeks.

Mortgage rates have bounced in a narrower range compared to the other consumer rates since the beginning of July according to the Freddie Mac weekly mortgage survey but are still lower over the past several weeks.  Thirty year fixed rate mortgages are now at 5.22% down from 5.32% on July 2, 2009.

The first consideration for review, for the interest rate sensitive investors, is whether the downward trend will continue.  If this turns out to be a long term trend it is a welcome change for borrowers but certainly sorry news for money market fund, bank CD and Treasury bond investors.  Most investors care about future interest rates, but none more than investors in financial vehicles like those just mentioned that are dependent on interest rate movements and the returns that come with them.

Unfortunately predicting the future direction of interest rates has eluded the best economists and Wall Street soothsayers recently.  The amusing battles between CNBC personalities Rick Santelli and Steve Leisman often display the vigor and polarized position on the future direction of interest rates.  These fighting factions, thumping their chests over predicting the future course of rates, are the camps of gorillas.

The first gorilla camp of interest rate prognosticators calls for higher interest rates in the immediate future.  The rationale is all supply based theory.  As the new administration of the U.S. government intends on running a budget deficit of a magnitude not seen in the history of the U.S. it must borrow large sums of money.  This money comes from issuing short and long term Treasury bonds to mostly institutional lenders that includes foreign governments.  The more the government intends to borrow, the greater the supply of debt it will need to issue which needs to be absorbed by these institutional investors.  At some point, as this level of borrowing reaches a high enough level, the U.S. government will be forced to increase the interest rate to stimulate further purchases of the debt from these buyers. 

The other camp of gorillas, think this is all wrong, and forecast rates to remain low.  The fundamental basis for this view is the prolonged recession.  The slow economy with delinquent credit cards, car loans and mortgages doesn’t seem likely to change.  A lackluster economy and severe credit delinquency will provide a cap of some significance on interest rates, especially if the Federal Reserve wants consumer lending rates and mortgage rates to remain low.  If banks borrowing rates do rise, consumers and businesses are likely to begin to curtail borrowing even further, if that’s possible.  Further restrictions in borrowing added to the already tough lending standards that exist in the market and the end of this recession will be years away.

A significant pillar to this theory is that a weaker economy brings about a flight to quality, increasing the demand for Treasury securities, which creates lower yields and rates.

To help cloud the debate, there is mist in the air brought on by yield curve analysis.  The shape of the yield curve is a key tool in interest rate fornication or prognostication.  Yield curve direction and shape is closely analyzed because it helps to give an idea of future interest rate change and economic activity.  Most interest rate mystics recognize that there are three general forms of yield curve shapes.  A normal yields curve, inverted curve and flat yield curve. 

The normal yield curve has higher interest rates on longer maturity debt instruments compared to shorter term bonds due to the general risks associated with the time value of money.  An inverted yield curve is the opposite look in which the shorter-term yields are higher than the longer-term yields.  This generally viewed as a sign of an upcoming recession.  In fact, this was the case in 2007.  January 2nd 2007 the 6 month Treasury rate was 5.11% while the two year was 4.80%, the five year yielded 4.68 as did the ten year Treasury bond. 

A flat yield curve is one in which the shorter term rates and longer term yields are in close proximity to each other, which is viewed as a prediction of economic transitions.  The yield curve eventually flattened in mid 2007, in the end of July 2007 the 6 month Treasury was t 4.99% while the ten year Treasury was at 5.00%. 

The slope of the yield curve is also viewed as having significance.  The bigger the slope of the curve which is caused by the larger spread between short term yields and long term yields the greater the magnitude of the upcoming adjustments.

Now, we jump to 2009 interest rates again.  The yield curve starts 2009 with 6 month Treasuries at 0.28%, 1 year Treasuries at 0.40%, five year Treasuries at 1.72% and the ten year yielding 2.46%.  An element of these low rates is brought about by the dramatic flight to quality.  The one year Treasury doesn’t break below 1% until November 2008.  Not two years ago but only nine months ago.  The low point is December when it hovers 0.15% and at the same time three month Treasuries hit 0.00%.

Moving on, March 2 of 2009 the 6 month Treasury is at 0.45%, the one year hits 0.67%, the five moves up modestly to 1.86% and the ten year leaps up to 2.91%.  The spread of 6 month to ten year has gone from 2.18% to 2.46%.

May 4, 2009 comes along and the short end moves slightly lower while the long end marches ahead.  6month Treasury is 0.33%, one year 0.52%, five year 2.03% and ten year Treasury hits 3.19%.  A spread of 2.86%.  Wider spread, normal curve and the short end is not moving.

August 3, 2009 and the 6 month Treasury is at 0.28%, the one year Treasury is at 0.48%, the five year Treasury has risen to 2.66% and the ten year is up at 3.66%.  The spread reaches 3.38%.

August has been a mess for long term Treasuries.  The ten year started the month at 3.52% then peaked at 3.89% on August 7 and rested lower at 3.45% on August 19.  The one year treasury started at 0.48% and peaked at 0.52% and closed August 19 at 0.43%.  The spread on the curve is now at 3.20% from the six month to the ten year.

Now let’s add the recent comments from the Fed at the meeting of the FOMC on August 11-12 of this year.  Here are some highlights from the Fed press release, not the media interpretations.

“…economic activity is leveling out.”
“Although economic activity is likely to remain weak for a time…”
“…the Committee expects that inflation will remain subdued for some time.”
“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
“As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year.  In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities”
“…anticipates that the full amount will be purchased by the end of October”  This is for the Treasury purchases not mortgage securities.

The yield curve has steepened, the Fed is going to reduce their debt purchases and the economy is an enigma.  According to the Fed notes, economic activity is leveling out but remains week, that equates to zero growth but no contraction one would assume.

Interest rate sensitive securities other than Treasuries, such as yields on bank CDs and savings accounts are generally set by the prevailing rates in other aspects of the credit markets including the Treasury market.  CD rates are correlated to US Treasury issues, but typically, CD rates start moving after significant rate movements in comparable interest bearing investments. 

If you are considering a bank CD investment, the quandary revolves around the present low interest rate environment.  An interest rate sensitive investor has to question whether they think interest rates will rise in the future.  If the answer is yes then bank CD investors should avoid long-term maturity CDs.

Well here is the summary of all of the above incomprehensible data.  Steep curve, no growth, no inflation, Fed keeps Fed Funds next to zero.  Which way are rates going?

Here is one point we can come away with, it is very difficult to forecast interest rates with any degree of accuracy.  Any investor, bank CD investor or equity investor, is well advised to consider their present financial condition and invest with greater diversification across assets classes and maturities.

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