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Would You Take Ben Bernanke's Advice About CD Rates?

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CD rates are so low that there is a strong argument to be made for keeping your money in short-term vehicles, so you'll have the flexibility to reinvest promptly when interest rates rise. However, based on the Federal Reserve's statement about interest rates in early August, you might have cause to consider moving into longer-term CDs.

In response to mounting concerns about the weak economic recovery, Ben Bernanke and the Fed announced that they would keep interest rates at extremely low levels for at least two more years. It was an extraordinary announcement--ordinarily, the Fed is somewhat evasive about what it intends to do next quarter, let alone over the next two years--and one which speaks volumes about the state of the economy. It could also have important implications for interest rates on CDs.

Interest rates on CDs

Ordinarily, there are two outlooks for interest rates that would encourage you to opt for longer-term CDs. If you thought interest rates were likely to fall, longer-term CDs would be an attractive way of locking in higher rates. If you thought interest rates were likely to stay the same, longer-term CDs would appeal simply because longer-term CD rates are generally higher than shorter-term ones.

On the other hand, if you thought interest rates were going to rise, you'd be inclined to keep your CD maturities short. After all, why lock into a lower rate today if you thought higher rates were just around the corner?

According to historical data from the Federal Reserve that goes back to the mid-1960s, CD rates are extraordinarily low right now. For example, six-month CD rates are near their all-time lows, and almost six percentage points below their long-term average. At 35 basis points, they don't have much farther to fall.

The fact that interest rates are unlikely to get any lower eliminates one reason for considering long-term CDs. However, what if interest rates were to stay at current levels for a long time? The Federal Reserve outlook suggests this is a strong possibility.

The Fed's outlook

Interest rates are likely to need signs of a sustainable economic recovery before they start to rise. This isn't really under the Fed's control--the Fed can manage short-term rates, but the markets determine other rates. However, those other rates have been sinking in response to discouraging economic news.

The Fed's announcement that it will keep its interest rates low through mid-2013 suggests that the economic picture won't get much better over the next two years. If Bernanke and the Fed are right about this, what does that imply about CD rates?

Spotlight on two-year CD rates

The Fed's announcement puts the spotlight on two-year CD rates. Conceptually, if you know interest rates are low but that the economy might continue to struggle for two years, a two-year CD would allow you to get a slightly higher interest rate now, while leaving you ready to capture higher CD rates if they start to rise in two years.

Unfortunately, at an average of 0.65 percent (according to FDIC figures), two-year CD rates aren't a whole lot higher than one-year rates. You may be better off shopping for the best one-year rate you can find, and hoping that the Fed's outlook is a little too pessimistic.

The original article can be found at Money-Rates.com:
"Would you take Ben Bernanke's advice about CD rates?"