CD rates are so low that there is a strongargument to be made for keeping your money in short-term vehicles, so you'llhave 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 concernsabout the weak economic recovery, Ben Bernanke and the Fed announced that theywould keep interest rates at extremely low levels for at least two more years.It was an extraordinary announcement--ordinarily, the Fed is somewhat evasiveabout what it intends to do next quarter, let alone over the next twoyears--and one which speaks volumes about the state of the economy. It couldalso have important implications for interest rates on CDs.
Interestrates on CDs
Ordinarily, there are two outlooksfor interest rates that would encourage you to opt for longer-term CDs. If youthought interest rates were likely to fall, longer-term CDs would be anattractive way of locking in higher rates. If you thought interest rates werelikely to stay the same, longer-term CDs would appeal simply because longer-termCD rates are generally higher than shorter-term ones.
On the other hand, if you thoughtinterest rates were going to rise, you'd be inclined to keep your CD maturities short. After all, why lockinto a lower rate today if you thought higher rates were just around thecorner?
According to historical data fromthe FederalReserve that goes back to the mid-1960s, CD rates are extraordinarily lowright now. For example, six-month CD rates are near their all-time lows, andalmost 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 areunlikely 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.
TheFed's outlook
Interest rates are likely to needsigns of a sustainable economic recovery before they start to rise. This isn'treally under the Fed's control--the Fed can manage short-term rates, but themarkets determine other rates. However, those other rates have been sinking inresponse to discouraging economic news.
The Fed's announcement that it willkeep its interest rates low through mid-2013 suggests that the economic picturewon't get much better over the next two years. If Bernanke and the Fed areright about this, what does that imply about CD rates?
Spotlighton two-year CD rates
The Fed's announcement puts thespotlight on two-year CD rates. Conceptually, if you know interestrates are low but that the economy might continue to struggle for two years, atwo-year CD would allow you to get a slightly higher interest rate now, whileleaving you ready to capture higher CD rates if they start to rise in twoyears.
Unfortunately, at an average of 0.65percent (according to FDIC figures), two-year CD rates aren't a whole lot higher thanone-year rates. You may be better off shopping for the best one-year rate youcan find, and hoping that the Fed's outlook is a little too pessimistic.
Theoriginal article can be found at Money-Rates.com: