Short-term CDs look best as rates should rise again

SUNDAY OUTLOOK

July 24, 1994|By John E. Woodruff

When Alan Greenspan presented his semi-annual report to Congress last week, he left open the possibility that the Federal Reserve would raise short-term interest rates for the fifth time this year. On the news, yields on longer-term issues rose, with the 30-year bond jumping 10 basis points.

Yet despite the higher rates (the Fed has already boosted short-term rates by 1.25 percent since February), and an expectation that the Fed might push up rates again in August, interest rates on certificates of deposit have risen only slightly this year.

With CD rates lagging, and interest rates considered likely to go higher, how long a term should savers choose when they buy a CD today? What makes CD rates rise so much more slowly than other interest rates?

Alfred G. Smith III

Chief Economist,

NationsBank

We would probably look for the Federal Reserve Board to tighten a couple more times this year, which would suggest keeping certificates of deposit to a relatively short term. You of course lose something on the immediate rate, but you probably can recoup that by rolling over later at a higher rate.

The financial system generally is not bidding very aggressively for consumer CDs right now. That is because banks currently have a very high liquidity, so even though loan demand has picked up substantially, there is not yet much need to draw in money through consumer CDs.

Consumer loan demand has picked up considerably in the past six months, and there is somewhat better demand for real estate loans, but the demand for business credit is much less than you'd expect at this stage of a recovery.

We expect loan demand to continue to pick up, but it seems likely that CD rates will continue to lag considerably behind the Fed's increases in the federal funds rate.

David Donabedian

Chief Economist,

Mercantile Bancshares Corp.

The direction of CD rates will be the same as the direction of short-term interest rates, and that leads you right to the Federal Reserve Board and its policy. Our view is that there will be at least another half-point added to the Federal Funds rates by the end of the year, possibly within the next month or so.

Of course you have to consider your own time horizon and your liquidity needs, but if we are right that short-term rates are going to be at least a half-point higher by the end of the year, then, all of the personal needs being equal, the direction of interest rates argues for staying short in order to take advantage of the higher rates we expect later on.

Robert K. Heady

Publisher,

Bank Rate Monitor

The bank rate outlook is definitely up, for one key reason. Interest rate cycles tend to run for a year and a half to two and a half years, and we are only five months into a new upward cycle. The odds are that a year from now, CD rates will be at least 1 percentage point higher than they are now. This is simply the law of the interest rate jungle -- what goes up must come down, and what comes down must go up. At this point in the cycle, the shrewd investor goes short with CDs, i.e. three to six months rather than three to five years. Going short now enables the saver to catch the higher rate next year.

Bank prime lending rates have gone up 1.25 points since February, right in line with what the Fed has done, but CD rates have gone up only two-thirds to one point. Where consumers get an edge right now is in borrowing, because consumer loan rates and home-equity loan rates also have not gone up as fast as the Fed.

Our latest survey shows that the average new car loan rate has gone up only from 7.91 percent to 8.42 percent since February, the average unsecured personal loan from 15.22 to 15.5, the average credit card from 17.51 to 17.65, the average home-equity line of credit, which is supposed to be tied to prime, only from 7.09 to 7.76, not nearly as much as the prime itself has gone up.

That is because banks are loaded with cash and ringing up record profits, and they are aggressively lending that money to consumers and businesses.

Demand for loans has risen, but it has nowhere near kept pace with the banks' cash.

I'm appalled that some oracles and gurus are still wondering in public whether the Fed will raise rates again. The question is not whether but when. The Fed will raise rates again by the end of September, and you can write that in stone.

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