The Best of the Worst CD Rates

The Best of the Worst CD Rates

Low interest rates are both a blessing and a curse. In an economy riddled with huge debt loads, low rates mean lower borrowing costs and lower monthly payments. Low mortgage rates are spurring waves of refinancing as new record lows are reached every few weeks. Thanks to the Federal Reserve’s zero interest rate policy (ZIRP), interest rates throughout the economy are lower than ever before. Certificate of deposit (CD) rates are pathetically low, so low that CD investors are being ravaged by inflation. CDs are similar to bonds, both being part of the fixed-income market. Bond and CD investors can arrange their purchases by maturity, creating a ladder from short-term to long-term securities.

The Federal Open Market Committee (FOMC) meeting on August 9, 2011 resulted in a decision to keep the Federal Funds Target Rate close to zero percent through mid-2013. This locked in the short-term end of the yield curve and effectively guaranteed low interest rates for the 2-year Treasury note. The yield on the 2-year fell to below 20 basis points or 0.2 percent. The benchmark 10-year yield fell below two percent for the first time ever. (1) Such record-low yields are reflecting increased investor demand for income, whether in bonds or CDs. CD rates are heavily influenced by bond yields, and low yields translate into low rates.

A brief glance at the current market for CD rates reveals a dire situation for investors. Record low interest rates combined with an inflation rate of 3.6 percent means that inflation is eating away at the fixed-income market. (2) The highest CD rate currently offered is a mere 1.27 percent. (3) At an inflation rate of 3.6 percent, this results in a real return of negative 2.33 percent. With a one year CD and a minimum balance of $1,000, a CD investor will lose $23.30 at the end of one year, leaving him with a balance of $976.70 in real terms.

Even the best of the worst CD rates are not enough to register gains against inflation in this environment. Fixed-income investors across the board are being taken to the cleaners, whether retirees or savers. Investing in CDs and bonds may be the only way to gain any investment income in this kind of economy. CD investors can look forward to inflation eating away at their returns for the next two years. Unless interest rates go up, the cost of living will continue to hurt fixed-income investors.