Strong CD rates should continue to reward savers
Certificates of deposit are earning more than they have in five years, and we expect these rather lucrative rates to stick around through the spring, maybe longer.
Our weekly surveys of major banks show six-month CDs have been paying an average yield of 3.6% APY -- the annual rate of return including interest on the interest you earn -- for several months.
That's nearly four times more than six-month CDs were earning when rates bottomed out in September 2003 at an absolutely pitiful 0.91% on six-month CDs.
And remember, those are just the average rates. Our CD rate comparison charts show that many banks are paying more than 5% on shorter-term CDs.
Interest.com's weekly survey of CD rates found the average annual yield for a:
- Five-year CD halted its recent slide. It held at 3.97%. The yield on the five-year has been trending down since August and is off by more than one third of a percentage point in that time. It is lower than the 4.06% of one year ago, and it's only one-fifth of a point higher than the 3.78% of April 2005.
- One-year CD was unchanged for the third straight week, holding at 3.79%. It is just over one-tenth of a point higher than the 3.65% it paid in April 2006. It is one and one-fifth points higher than the 2.61% of two years ago.
- Six-month CD was unchanged at 3.63%. The yield on the six-month CD has been on the rise after bottoming out at 3.54% the first week of January. It is now up more than half a point from the 3.19% of one year ago and it is over one-and-a-half points higher than the 2.19% of April 2005.
- Three-month CD held at 2.93%. This yield has jumped back and forth between 2.93% and 2.94% since January 10. It is up one-third of a point from 2.59% last April and it is almost a point-and-a-fifth higher than it was two years ago.
Despite the weekly ups-and-downs, most CD rates have been relatively stable going on nine months now -- ever since the Federal Reserve Bank ended its two-year campaign to push them higher back in June 2006.
It's impossible to predict with any confidence when the Fed might change rates again, or whether it will raise or lower them when it does act.
The Fed's job is to protect the buying power of our money from runaway inflation.
When the Consumer Price Index began to post worrisome increases back in 2004, the Fed sought to bring inflation back under control by raising interest rates.
Here's how that's supposed to work:
The Fed is a super bank, lending money to all the commercial banks we deal with every day. When it begins charging those banks more to borrow money those banks pass that cost along to us by raising rates on virtually every type of consumer loan and savings account, including CDs.
We respond to that pressure by spending less and saving more, making it more difficult for everyone from furniture makers to hair stylists to raise prices. That brings inflation under control.
From June 2004 until June of 2006, the Federal Reserve's rate-setting committee was absolutely predictable, pushing interest rates up at 17 straight meetings and making CDs a respectable investment again.
But in July, Fed Chairman Ben Bernanke told a Senate hearing that all those rate hikes seemed to be working. We were spending less. The economy was finally slowing and inflation would surely follow.
At its last six meetings -- the most recent held on March 21 -- the Fed left rates unchanged and the most recent inflation reports indicate Bernanke is right and inflation is indeed slowing.
The most recent inflation report showed big monthly gains in food and energy prices, and those were reflected in a 0.4% increase in the overall Consumer Price Index in February. The CPI rose only 2.5% in 2006, well below the 3.4% increase in 2005. But the CPI core rate, which is more closely watched by the Fed because it eliminates volatile food and energy prices, rose by a tepid 0.2%.
This means the Fed has a tough choice each time it meets. It can:
- Resume raising rates if inflation suddenly spikes again. While the Fed's leaders have repeatedly said they're willing to do that, the latest inflation data indicates that's unlikely.
- Leave rates unchanged if inflation is in check and the economy slows but continues to grow. This is what everyone calls a "soft-landing" and an increasing amount of economic data shows we may have hit this financial sweet spot.
- Lower rates if the previous increases have gone too far, our spending drops too much, the economy topples into a recession. While there's some worrisome evidence, we won't have enough information to tell if that's the case, and prompt Fed action, until spring.
As a result, we could sail through much of the year with CD rates right where they are today. Or they could be a quarter- or half-point lower.
That's why we think the smart move is to accept that uncertainty and take advantage of the best, short-term rates you can find.