Slide in Yields Takes Luster Off Bank CDs

Certificates of deposit no longer offer the yield advantage they did a few months ago, but savers looking to keep their cash earning decent yields might still want to lock in current rates--before they go lower.

The Federal Reserve is scheduled to meet Tuesday to discuss whether to cut interest rates for a fourth time this year. While most economists predict the Fed will leave rates unchanged, bank observers caution that another rate cut--next week, or in the first quarter of next year--could send CD yields tumbling again.

For a few weeks in September and October, CDs were a great deal for investors who wanted a safe haven for their cash. Nationwide, average yields on six-month, one-year and five-year CDs were higher than yields on comparable U.S. Treasury securities--a rare event last seen in 1989.

Since then, however, CD yields have fallen faster than yields on Treasuries, erasing most of the advantage of taking your money to the bank versus buying Treasuries.

The average yield on a one-year CD has fallen from 4.93% in mid-September to 4.38% now, a drop of 0.55 percentage point, according to RateGram, a service that tracks deposit yields nationwide.

By contrast, the one-year Treasury bill yield has fallen just 0.23 point, from 4.68% to 4.45%, in the same period.

Six-month T-bills also now pay more than CDs of comparable maturities, as CD yields have fallen about twice as much since mid-September.

(Also keep in mind: Treasury interest is subject to federal income taxes but not state tax; CD interest is fully taxable.)

Shorter-term interest rates have fallen across the board as the Fed has slashed its benchmark short rate--the federal funds rate, or overnight loan rate among banks--from 5.5% to 4.75% in three cuts beginning Sept. 29.

But Treasury yields have been somewhat buoyed by calmer international markets. Risk-averse investors are no longer piling into Treasuries as they did in late September and early October, which led to precipitous drops in their yields.

As global markets have stabilized, Treasury yields have moved back up from their lowest points in mid-October.

Banks, meanwhile, have taken greater-than-expected advantage of the Fed’s cuts to trim the yields they pay depositors, said Greg McBride, a financial analyst with Bank Rate Monitor newsletter.

“They [cut] because they can,” he said.

Still, the decline in CD yields has fallen short of the Fed’s 0.75-point cut in its key rate since Sept. 29.

Bank CD cuts have been limited by still-strong loan demand, which means banks need to attract deposits to fund new lending.

But McBride warns that if the Fed continues to cut its benchmark rate in the months ahead--a strong possibility if the economy slows--”nobody knows where the bottom is” for CD yields.

Savers willing to shop around can still find relatively high rates on federally insured CDs, although the top rates are more than half a percentage point lower than they were in September.

Net.Bank ([888] 256-6932) offers a one-year CD yield at 5.45%, according to Bank Rate Monitor. Providian National Bank ([800] 414-9692) pays 5.35% on the same maturity, while Southern Pacific Bank ([800] 428-5056) advertises 5.34%.

Meanwhile, the average seven-day money market mutual fund yield has fallen to 4.61% from 5.15% in mid-September, according to IBC’s Money Fund Report.

That’s higher than the average CD yields for six-month and one-year maturities. But remember: Money market yields can change daily, and could be much lower by spring if the Fed cuts rates again.

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Tracking Yields

For a few weeks in September and October, investors had a rare opportunity to earn more from the average bank certificate of deposit than they could from a comparable U.S. Treasury security. But average CD yields have since fallen much more sharply than Treasury yields. Examples:

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Instrument Sept. 18 Thursday Change 6-month CD average 4.67% 4.21% -0.46 points 6-month Treasury 4.78 4.53 -0.25 1-year CD average 4.93 4.38 -0.55 1-year Treasury 4.68 4.45 -0.23 5-year CD average 5.19 4.66 -0.53 5-year Treasury 4.51 4.36 -0.15

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Source: RateGram, Bank Rate Monitor