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Updated on Thursday, April 4, 2019
If you pay attention to financial markets, you probably know that the U.S. Treasury yield curve helps investors understand the direction of interest rates as well as broader economic trends. But have you ever taken a look at the certificate of deposit (CD) yield curve?
The recent changes in the federal funds rate have impacted the annual percentage yields (APY) — and the yield curves — of U.S. Treasuries and CDs in different ways. Our analysis examines these differences, and what they mean for your savings strategy.
Thanks to the consistent Fed rate hikes over the last three years, CD yields have been staging a notable recovery from the ultra-low levels seen in the wake of the Great Recession. Longer-term CDs have seen slightly bigger yield increases than CDs with a maturity of one year or less. The average rate on a 5-year CD increased from 1.27% APY in March 2014 to 2.26% in March 2019, while the average rate on 1-year CDs went from 0.42% APY to 1.36% in that same time period.
However, the Fed has made it pretty clear that 2019 will see few, if any, rate hikes. Treasury yields have fluctuated rapidly, and the Treasury yield curve has flattened and even inverted in response to the Fed’s evolving rate strategy, not to mention softer economic data. CD rates have begun to plateau, especially the longer maturities. CD yields are bound to catch up with Treasuries; given this outlook, it may be time to get the CD ladder down from the attic.
- The CD yield curve has steepened in recent years. Meanwhile, the more carefully watched Treasury yield curve has flattened over recent months. The flatter Treasury curve has been a cause for concern, as it can signal an upcoming recession.
- CD rates are currently offering more competitive rates than last year, on average, particularly for longer-term CDs. Before taxes, the average 5-year CD has a 2.24% APY as of February. This falls just 0.30 percentage points behind 5-year Treasury Note (at 2.54%), compared to being 0.97 percentage points behind a year ago.
- The spread between the 1-year and 5-year average CD rate is nearly 1 percentage point — remaining roughly the same over the past 5 years.
Breaking down the data
The following data visualizations allow us to take a deeper dive into some of our key findings. We’ll take a look at:
- Changes in the CD yield curve since 2014
- The difference in percentage points between Treasury notes and their CD counterparts
- The spread between 1- and 5-year Treasury notes have fluctuated much more than CDs
We had been seeing incremental increases in CD rates across all terms in the period between 2014 and early 2018. By February 2019, the CD curve (shown below in red) had moved significantly higher after the aggressive rate tightening of 2018. As the Fed really stepped up its rate hikes that year, CD investors saw ever higher yields.
Below, you see the difference (in percentage points) between Treasury note yields and CD yields, in maturities between 6 months and 5 years. Back in 2014, you can see that shorter-term CD rates topped Treasury rates, while the 5-year CD was much weaker. That trend has reversed. In January, 5-year CDs fell 0.33 percentage points behind 5-year Treasury notes, while the average 6-month CD is 1.70 percentage points behind.
The spread between 1- and 5-year CD rates haven’t changed much since 2014. This means that with each change in average 1-year CD rates, for example, 5-year CD rates have changed proportionally. The spread between 1- and 5-year Treasury rates, however, have been much more volatile over the same period. In January, we even saw a negative spread — indicating an inverted yield curve — where the 1-year rates were higher than the 5-year rates. Like the chart above, this data shows that treasury yields of different maturities are much more responsive to changing rates, and that CD rates are much slower to respond.
CD yield curve vs. Treasury curve
In the simplest of terms, a yield curve helps us look at the relationship between rates (on the y axis) and maturities (on the x axis) on a graph. The U.S. Treasury yield curve looks at the rates and maturities of U.S. Treasury securities, where maturities range from one month to 30 years. A CD yield curve compares the rates and maturities of banks’ retail CD accounts.
A normal yield curve slopes upward to the right, with longer terms delivering notably higher yields than shorter-term maturities. Yield curves can become abnormal, however, signaling possible trouble ahead. A flat yield curve illustrates little change between short- and long-term rates. An inverted yield curve happens when shorter-term yields are higher than longer-term yields, indicating that investors have little trust in the returns offered by long-term investments.
The chart above compares the current CD yield curve against the current Treasury yield curve. The CD curve looks normal and healthy, while the Treasury curve is flat, which is considered less normal and less healthy. You can also see how narrow the spread is between the average 5-year CD rate and the 5-year Treasury note was in February.
A flattening Treasury curve can signal a recession
A yield curve indicates the direction that investors predict rates are going to go. Looking at the CD yield curve, we can see that consumers are still opening 5-year accounts with high interest rates. This hints that investors predict a future drop in rates, pushing them to lock in high rates now for the long term.
The U.S. Treasury curve is much more volatile, determined by the current supply and demand of U.S. Treasury securities, and day-to-day changes in the market environment. In addition, short-term securities are directly affected by Fed economic policy through the federal funds rate (which also determines deposit rates like those for CDs). Because of these ties, the Treasury curve gives us an idea of where the broader economy might be headed. A flat curve often predicts economic changes ahead. Meanwhile, an inverted yield curve, like the one we’re seeing now, has often been associated with an upcoming recession. An inverted yield curve, where longer-term yields fall behind short-term maturities, suggests diminishing potential of longer-term investments.
How to use a CD ladder to your advantage
While there’s no way of predicting exactly when banks plan to change CD rates, you can use the yield curve to inform your CD investing strategy, especially in an economic transition period like the one we find ourselves in now.
When you build a CD ladder, you are depositing funds in multiple CDs with varying maturity dates. You can lock in the high rates on long-term accounts and still have the chance to snag even higher rates on shorter terms, like 1-year accounts. A CD ladder can also serve as a semi-steady stream of income every year or so, depending on how you build it.
By understanding the CD yield curve, you’ll have a read on whether to base your ladder on longer-maturity CDs or shorter-term ones. Today’s normal CD yield curve indicates some trust in CD rates to keep steady. However, the Fed’s pause on rate hikes could signal some upcoming changes in the CD yield curve.
“As we have seen in the last few months, CD rates can start falling pretty fast, long before the Fed changes direction,” said Ken Tumin, founder of DepositAccounts.com, a LendingTree-owned site. “So I think the basic CD ladder that matures into regular renewals of 5-year CDs is still the best choice.” That way, you can maintain high yields even if the economy takes a turn for the worse and rates begin to fall even further.
To maximize your earnings across the years, you won’t want to open any old CD. Look for the best CD rates to ensure you’re growing your money as efficiently as possible. For example, you can get a #CDRates.goldman APY on a 1-year CD at an online bank compared to a paltry 0.05% APY at a traditional brick-and-mortar bank. The online bank can grow a $5,000 deposit in a year by about $140 while a brick-and-mortar bank yields only $2.50. Since you’re setting aside that cash for months at a time, you’re going to want to make it worthwhile.
Another way to strengthen your CD ladder is to find CD accounts with low early withdrawal penalties. These penalties can take a big chunk out of your savings if you’re not careful, as they typically charge months worth of earned interest. Finding a bank with low penalties can minimize your losses if you ever need to dip into a CD account before maturity. Or, you can even find several no-penalty CDs. These are more limited in term lengths, but you can rest easy knowing you won’t lose money should you need to access your funds early. This is helpful if you need some cash in a pinch — or if you find higher rates halfway through your term.
MagnifyMoney compared the average Certificate of Deposit (CD) rates, as collected by DepositAccounts.com, examining the changes in Annual Percentage Rates over time, and the difference in yield between CDs and U.S. Treasury Notes, as measured by constant maturity rates.