THE BLOG
07/20/2011 05:04 pm ET Updated Sep 19, 2011

How You Can Follow the Changing Fortunes of CD Rates

Financial news seems to be changing at a dizzying pace these days. It can make decisions about things like CD rates even more difficult, but there is a simple method that will help you put fast-developing events into context.

Choosing the right terms and interest rates on CDs is especially challenging because it involves a decision not just about the present, but about the future. After all, locking yourself into a rate for as much as five years is a big commitment; at the same time, failure to lock up a rate can cost you. To help you understand the economic context for those decisions, try the four-corner approach.

The four-corner approach

Imagine a grid with four boxes - two up, and two down. Along the left side of the grid, imagine a range of economic growth scenarios, from low to high. Along the bottom of the grid, imagine a range of inflation outcomes, again from low to high. Thus, each of the four boxes represents a different combination of growth and inflation outcomes.

Broadly speaking, the four combinations are as follows:

  1. Low growth, low inflation. This would not bode well for higher CD rates, but at least you wouldn't be losing much ground to inflation.
  2. High growth, low inflation. This would be conducive to higher interest rates, while not exacting a toll from rising prices. In other words, the best of both worlds for CD rates.
  3. High growth, high inflation. This would be something of a wash for depositors, as CD rates and inflation chased each other upward.
  4. Low growth, high inflation. The worst-of-both-worlds scenario for CD rates.

As economic events occur, you can think about how they shift the outlooks for growth and inflation, and accordingly, which box the prevailing environment for CD rates seems to fit.

Where things stand now

Recent developments have been mixed for CD rates. Thinking first about the range of economic growth outcomes, indicators would have to be pointing more and more towards slower growth. Weakening job growth, the European debt crisis and brinksmanship in the U.S. budget debate have all added uncertainty to the economic outlook. In terms of the U.S. budget debate, even looking past the short-term uncertainty, there is the cold, hard reality that any solution is going to involve some form of drag on growth - either budget cuts, tax increases, or both.

This darkening growth outlook is reflected in the sudden plunge that bond yields took in early July 2011, wiping out substantial gains from late June. As one might expect, fading prospects for the economy are translating into lower interest rates.

On the inflation side of the grid, the news is a little better. Oil prices have weakened, and that should remove a key source of inflation pressure. So, while inflation indicators have been rising for much of this year, they seem to be backing off now.

Surprisingly then, developments in recent weeks are a net positive for CD rates. For a while there, the outlook was in the low-growth, high-inflation corner of the grid, which is the worst of both worlds for CD rates. Now things are pointing towards the low-growth, low-inflation corner. That's not optimistic for higher CD rates, but even today's rates would be worth more in a lower inflation environment.


The original article can be found at Money-Rates.com
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