This year was suppose to be the year of rising CD rates. As is typical with interest rates, they often don’t turn out as you expect.
With the global economic turmoil and the stock market volatility this year, the four Fed rate hikes that were expected for this year now appear to be very unlikely. If the global economic slowdown impacts the U.S., we may not see any additional rate hikes. In fact, the Fed could even undo its December rate hike. With central banks in Europe and Japan setting rates to negative, it’s even possible that the Fed may feel necessary to cut rates below zero if a recession hits the U.S.
All of this economic pessimism has spilled over to the banks. Several banks appear to be preparing for an economic slowdown by cutting CD rates. Also, they may have seen a surge of new deposits in January and February as scared investors moved their money into safe deposit accounts.
Investor fears are often first seen in Treasury yields. When stocks are tanking, investors typically flee to the safe assets like Treasury notes and bonds. That forces down yields. Treasury yields have plummeted this year. At the start of January, the 5-year Treasury note had a yield of 1.73%. Last Friday, the yield was at 1.24%.
With 5-year Treasury note paying only 1.24% and the 10-year Treasury note paying only 1.76%, you can see that 5-year CDs paying over 2% are attractive by comparison. Since brokers make it easy for investors to open brokered CDs, it’s typical to see brokered CD rate changes follow Treasury yield changes. The rates of the top 5-year brokered CDs offered through Vanguard has plummeted this year. In early January, the top 5-year non-callable brokered CD had a 2.30% rate. Last week it was down to 1.80%.
Most direct CD rates have held up better than the brokered CD rates. However, we have seen several CD rate cuts in the last few weeks. Below are a few of the noteworthy ones:
CD Strategy for Savers?
Should you lock into a top long-term CD now before rates fall more? Or are these recent rate declines temporary? A lot depends on the U.S. economy. If you think we’re heading into a recession, we’ll probably see a lot more rate declines. As I mentioned above, it’s not easy to predict interest rates. That’s one reason CD ladders always make sense. With CD ladders, you don’t worry about deciding the terms of your CDs based on future expectations of interest rates. You just keep renewing them into new long-term CDs with the same terms you had before.
Mild Early Withdrawal Penalties
Whether or not you choose a CD ladder approach, it always makes sense to give more weight to long-term CDs with mild early withdrawal penalties. Below are a few banks and credit unions (Barclays, Alliant Credit Union, Synchrony Bank and Ally Bank) that currently have both competitive 5-year CD rates and mild early withdrawal penalties:
If you want to compare the effective yields of CDs after the early withdrawal penalties, please refer to our CD early withdrawal penalty calculator. The risks of planning for early withdrawals have been seen at credit unions which have raised the early withdrawal penalties on existing CDs. I have more details in this blog post.
Make sure to keep a copy of the disclosure showing the early withdrawal penalty at the time you open the CD. If you need to do an early withdrawal, make sure to check the penalty to ensure it equals the penalty as described in the disclosure. DA member Cactus mentioned in the DA forum that a bank had wrongly charged him the current EWP rather than the one that was in effect for his CD. He reported the error to the bank, and they quickly gave him credit. If he hadn’t caught the bank’s mistake, he would have paid double the penalty.
Bump-Up and Add-On Features
A mild early withdrawal penalty provides some benefit if rates rise. One type of CD that helps you when rates rise is a CD that has a bump-up option. Instead of closing your CD and moving your funds into a higher-rate CD, you just use the rising-rate option to bump-up the rate to the new higher rate that’s being offered on the same CD. With these bump-up CDs, there’s always the risk that the bank won’t keep the new bump-up CD rates competitive. If rates increase, it doesn’t necessarily mean the bump-up CD rate will increase.
A mild early withdrawal penalty or a bump-up option won’t help you deal with a falling-rate environment. The one thing that can help is an add-on CD. If rates fall, you have the option of adding to your existing add-on CD rather than opening a new CD. With add-on CDs, beware of small institutions that have add-on CDs which are too generous. Typically, banks and credit unions will limit the add-on deposits by the number of deposits and the amount of the deposits. As we learned with Valor Credit Union, managers may not understand how costly an unlimited add-on CD can be.