A Word From the Pros to CD Savers: Yields Haven't Peaked

Almost one year to the day since the Federal Reserve Board started raising short-term interest rates, the seventh such increase is expected today.

Wall Street is hoping this hike will be Lucky 7--the one that finally slows the economy and sets the stage for a renewed decline in rates, perhaps later this year.

Millions of Americans who live off bank CD interest income, however, have a different agenda: After enduring plunging yields from 1990 through 1993, CD owners obviously don't want the turnaround in rates to end after just one year.

The good news for those savers, some experts say, is that short-term CD yields and money market mutual fund yields still have upward momentum, even if other interest rates stabilize.

What's more, even though longer-term bond yields have been coming down in recent weeks--hinting that the economy is indeed losing steam--savers ought to avoid feeling panicked to lock in long-term yields, many pros say. You will probably get an opportunity to pick up comparable or better long yields in the months ahead.

Here's a look at what the Fed is expected to do today and how that relates to yields on CDs, money funds and other shorter-term investments:

* CD yields aren't necessarily "at market" yet. Wall Street is virtually certain that the Fed will raise the federal funds rate--the overnight loan rate among banks--from the current 5.5% to 6%. The goal, of course, would be to see that increase ripple through the banking system, raising the cost of credit for businesses and consumers and thus dampening demand for money.

From an investor's point of view, a half-point rate rise has already been factored into "market" rates, such as the 6.01% current yield on three-month Treasury bills, says Marilyn Schaja, money market economist at DLJ Securities in New York. So three-month, six-month and one-year T-bill yields may get no lift from the expected Fed hike.

Yields on CDs at many banks and S&Ls;, however, should continue to push higher after the Fed acts--or even if it doesn't, argues Robert Heady, publisher of Bank Rate Monitor in North Palm Beach, Fla.

Why? Because the banks are still playing catch-up to market yields. Typically, banks are slow to raise CD yields when interest rates turn. But since late summer, the banks have been boosting yields at a brisk pace.

Since just before the last Fed rate hike on Nov. 15, for example, the national average one-year CD yield has surged 0.83 points, to 5.76% now, according to Heady. The one-year T-bill yield, in contrast, has risen 0.30 point in that period, to 6.80% now.

Banks are getting more generous for a simple reason:

* The economy may be slowing, but loan demand isn't--yet. Banks are competing aggressively for consumer deposits because even at higher rates, those deposits are still the cheapest source of funding. And because loan demand continues to rise sharply, banks need to attract more deposits with which to make loans.

Ed Yardeni, economist at C.J. Lawrence/Deutsche Bank Securities, says major loans outstanding at commercial banks jumped $7.4 billion in the week ended Jan. 18 (the latest figures available) to $2.12 trillion. Through the first three weeks of 1995, loan growth is averaging a spectacular $6.5 billion a week, Yardeni says.

Given that kind of loan demand, it's no wonder that banks and S&Ls; have continued to bid up deposit rates since Jan. 1, even as T-bill yields--the nominal benchmarks for CD yields--have flattened or eased. Heady, who surveys hundreds of banks each week for his newsletter, says that in the latest week, eight banks were still raising CD yields for every one bank cutting yields.

* Money market fund yields also are going up, with or without the Fed. Whether or not the central bank is nearly finished raising short-term interest rates, investors in money market mutual funds will earn higher returns in the months ahead. That's because fund managers have been keeping their dollars in very short-term securities, but now they will probably begin lengthening the funds' maturities, says Ralph Norton, analyst at money fund tracker IBC/Donoghue in Ashland, Mass.

The average maturity of taxable money funds now is 36 days, the shortest in several years, Norton says. The funds' average seven-day yield is 5.17%. If fund managers begin moving more of their dollars into longer-term securities (say, by adding some 12-month securities to the portfolio) their yields will rise automatically, because longer-term investments pay more than shorter-term investments.

Thus, the funds can pay higher yields in the months ahead even if the Fed does nothing to short-term rates.

* The bottom line: Higher CD and money fund yields will pay investors for patience. It's tempting to want to believe that the economy is already slowing so significantly that investors should lock in very long-term yields today, for fear they'll never see those yields again. But many Wall Streeters warn that interest rate tops generally are long processes. And long-term yields usually don't fall precipitously--and stay down--until the Fed begins cutting short-term rates. All Wall Street is hoping for now is that the Fed is nearing the end of its credit-tightening cycle. No one is yet suggesting that the Fed is ready to start easing again.

So Heady and others suggest that keeping plenty of cash in money funds or short-term CDs still is a smart idea. Perhaps the easiest strategy: Divide your savings among a money fund and CDs maturing in three, six, nine and 12 months. That way, you'll always have some cash rolling over and available for new ideas.


Surge in Short Yields

Comparison of 1-year T-bills and average 1-year CD yields at key junctures over the past 13 months:


1-yr. CD: 3.08

1-yr. T-bill: 3.59


1-yr. CD: 4.19

1-yr. T-bill: 5.57


1-yr. CD: 4.93

1-yr. T-bill: 6.50


1-yr. CD: 5.76

1-yr. T-bill: 6.80

Source: Bank Rate Monitor

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