I got an e-mail last week from a reader who had found a 5-year CD rate of 3 percent and was wondering if he should jump on it. He knew the rate was above market -- the highest 5-year CD rate I find on Bankrate's CD rate table is 2.4 percent -- but he was concerned about locking his money up for 5 years at a historically pretty low CD rate.
Unlike most other types of investments, CDs are back-stopped by FDIC insurance and thus are essentially immune from losing principal. Instead, the biggest danger is going "long and wrong" -- locking money up at a long-term rate that turns out to be too low. Not only does that deprive an investor of return if CD rates later rise, at worst it can also actually result in a net loss of value due to rising inflation.
But is the potential for runaway inflation really something today's CD investors should be worried about? Here are a few data points:
- Inflation is currently pretty low. According to the latest numbers from the Bureau of Labor Statistics, core inflation, or the change in the Consumer Price Index minus food and energy prices, was at 1.6 percent over the last 12 months. When you factor in food and energy, inflation rose 3.6 percent, but that's mostly a result of the massive run-up in gas prices since last year.
- The Cleveland Fed, which tracks inflation expectations, shows inflation expectations for the next 10 years have been hovering at or below 2 percent since the financial crisis hit in 2008, coming in at 1.83 percent in the most recent estimate. What that means is, according to the Cleveland Fed's calculations, the U.S. public believes inflation will be at or below 2 percent per year for the next 10 years. If that's indeed the case, then the reader in question can count on making 1 percent above inflation. That's not going to make him rich, but considering it's free of principal risk, that's not bad.
- According to the latest numbers from the Treasury, 10-year Treasuries are currently carrying a rate of 2.82 percent, and 5-year Treasuries are at 1.35 percent, much lower than the aforementioned readers' sterling CD rate.
- Since the Fed tamed stagflation in the early '80s, rising inflation has typically accompanied accelerating economic growth. Recently, the Commerce Department announced the economy grew at only a 1.3 percent rate between the second quarter of 2010 and the second quarter of 2011, and to top it off, lowered its first-quarter number from 1.9 percent to less than .4 percent. These are not the kind of growth numbers economists associate with rampant inflation, to say the least.
- Spiraling government deficit spending can sometimes push inflation higher. But with the federal government embracing austerity and budget cutting, most recently in the debt-limit increase deal awaiting passage in Congress, it's unlikely government spending will increase to the point where we get galloping inflation.
- The Fed can sometimes push inflation higher by lowering interest rates and pumping money into the economy via monetary easing. Currently, the federal funds rate, one of the main levers the Fed pulls to lower interest rates, is near zero, and the Fed doesn't have plans for another big quantitative easing program, so inflation pressures are unlikely to come from the Fed anytime soon.
I'm no economist, but to my eyes, there are just not a lot of signs runaway inflation is anywhere close-by. Sure, today's CD rates are low by historical standards, but what really matters is return after inflation, and if inflation stays this low, today's rates might just be good enough.
What do you think? Should CD investors fear inflation?