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CD Rates and the Search for Yield
Investors who frantically search for any kind of yield in an environment with record low interest rates constantly come up short. This has been the case since the financial crisis of 2008 first began to appear in 2007. The Federal Reserve lowered the Federal Funds Rate from five percent in 2006 to zero percent in December 2008. (1) This was meant to cushion the blow of the crash in stocks and a contracting economy. Unfortunately, this zero interest rate policy (ZIRP) has left savers and conservative investors without a home. Traditional instruments of the virtue of prudence, such as certificates of deposits (CDs), money market accounts and bonds, have depressingly low yields.
Finding a decent yield on a CD is like finding gold on the Moon. The best CD rates are yielding just above one percent, hardly enough to beat an annual inflation rate of 3.6 percent, as measured by the Consumer Price Index. (2) As an example, the highest yield offered on a one year CD is 1.2 percent from Sallie Mae, a private corporation that offers student loans. (3) Compounded daily on $1,000, this works out to be about $12 per year in interest payments. Investors are practically choking to death on this kind of yield.
Most financial advisors would tell their clients to seek out conservative, dividend-paying stocks in this kind of situation. The stock market has exhibited enormous volatility over the summer, making investors jittery. This volatility is the market’s reaction to turmoil in the Middle East and the intensifying European debt crisis. 2011 has been a year to remember so far, with “black swans” popping up left and right, from the Libyan war to the Japan earthquake. Investors have been retreating into bonds, lowering yields on these instruments as their prices rise in response to market demand.
The final result may be an inflationary crisis where interest rates are forced up, much to the chagrin of the Federal Reserve as ZIRP goes up in smoke. This would benefit savers and bond investors at the expense of stock and commodity investors. Barring a crisis of this nature, the Federal Reserve may attempt another intervention to bolster the economy. Operation Twist, first performed in the 1960s, involves selling short-term Treasury notes and buying long-term Treasury bonds, inverting the interest rate term structure or yield curve.
After the employment report released on September 2 showing job growth slowed to zero, market participants confidently expect the Federal Reserve to announce another version of Operation Twist at its next meeting. (4) This would have the effect of raising short-term interest rates, which may benefit holders of CDs with maturities less than one year. Money market investors would also reap the rewards because the money market trades in short-term debt securities.