CD rates could suffer if the Fed takes further action to boost the economy.
In addition to an extension of its "Operation Twist" program, Federal Reserve Chairman Ben Bernanke hinted that the central bank could launch another round of quantitative easing if economic indicators don't improve. Here's Bernanke:
The outlook has changed. Like many other forecasters, the Federal Reserve was too optimistic early in the recovery about the pace of recovery. And we've had to add additional accommodation going forward as we have seen in fact that the headwinds have kept the recovery from being as strong as we would like. But again, by the nature of these unconventional tools, they ... tend to be more discreet in their size, but they continue to have accommodative effects even after the pattern of purchases has ended.
We've taken a step today which is a substantive step, which will provide additional accommodation for the economy. And moreover, we have stated that we're prepared to take further steps if necessary to promote sustainable growth and recovery in the labor market. So, we are prepared to do what is necessary. We are prepared to provide support for the economy.
Quantitative easing, or QE, is a wonky way of saying the Fed will buy Treasuries in order to push down interest rates, hopefully stimulating the economy.
While the idea is to flood the economy with greenbacks to get businesses and consumers spending again, that flood has a tendency to drown CD investors. That's because movements in CD yields closely track movements in Treasury rates, so when the latter goes down, the former tends to go with it. Since 2001, Bankrate's five-year CD average and the five-year Treasury have shown a correlation of 0.94 (1 is a perfect correlation).
That's in part because CDs and Treasuries are similar products, both intended to be safe storehouses of money backed by the full faith and credit of the U.S. government. If Treasury rates go down, banks don't have to pay as much interest to compete successfully with Treasuries and attract investors to their CD accounts.
To draw an analogy, imagine if Zephyrhills increased the price of a gallon of its bottled water by $1. A competitor offering a similar product, such as Glacier Mountain, would then have more leeway to raise prices without the risk of losing customers.
It follows then that if the Fed decides in the coming months to try and push down interest rates on medium- and long-term Treasuries under a new round of QE, lower CD rates will follow, and savers will again bear the cost of stimulating an economic recovery that continues to be elusive.
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