We use cookies to optimise our site and allow us and 3rd parties to tailor ads you see on sites. By using this site you agree to our cookie policy.


The Chart Which Shows The FED Controls CD rates

CD Rates FedIn the article, “I Know Where CD Rates Will Be In 2015! Why doesn’t Nobel Laureate Thomas Sargent”, Learn Bonds makes the following claim:

National short term CD rates (6 month, 1 year, 2 year, 30 months) closely follow the FED funds rate which is controlled by the fed

In this article we will provide the empirical support for that statement. First lets define what we mean by short-term CD rates. We mean CD rates of 30 months or less. If in the chart below we used the interest rate on the 5 year CD instead of the 30 month, the relationship would not appear to be as direct.

The Fed has two main ways in which it controls short-term interest rates:

  1. By setting a public target for the FED Funds rate
  2. By selling and buying short-term treasuries. As a result, and as the chart below shows, CD Rates and the FED Funds Rate move in tandem.

The chart below shows that CD rates also move in tandem with short-term treasuries and the FED Funds rate, except when the Fed Funds rate is very high or very low.

Green Line – Fed Funds Rate
Red Line – 2 Year Treasury Rate
Blue Line – 30 Month CD Rate

Why does there appear to be natural levels where CD rates resist the pull of monetary policy? For the 30 month CD, these levels appear to be above 3% and below 1%. Between these levels, the rate very closely tracks the FED Funds rate. While the CD rate will follow the direction of the the other rates above and below these levels, the move in CD rates is much slower and takes longer to occur. There seems to be an absolute floor at the CD rate of 0.26%

Despite, the FED funds rate being around 0.12% since 2009, over three years, both the CD rate and the Treasury rate will not go below this level. I believe there is both a psychological and practical reason for this.

The Psychology of CDs

CDs are consumer products. In other words, they are primarily purchased by non-financial professionals. Just like laundry detergent, consumers have a general feeling about how much they should be earning on a CD. A 30 month CD that earns above 3% or more  is “a good rate”. Below 1% is “a bad rate” which might drive a consumer to look for alternative higher paying CD. I think once the yield goes below 0.25%, consumers have the attitude “why bother” as below that level consumers feel the rate might as well be zero.

Practical Reason

Most CDs have large penalties for early withdrawals. At very low rates, the perceived opportunity cost for locking up money for a couple years is considered less than the forgone interest. In short at less than a 1 %, some  investors start putting more money  into savings and checking accounts where there is no penalty for moving money. At a quarter percent, a savings account is considered a better choice for most.

Learn More

How to Build an Emergency Fund Using a CD Ladder
What CD Length Should I Buy?
What is a Brokered or Auction CD?
Jumbo CDs, Bump Up CDs, and No Penalty Withdrawal CDs
How to Build a CD Ladder

All trading carries risk. Views expressed are those of the writers only. Past performance is no guarantee of future results. The opinions expressed in this Site do not constitute investment advice and independent financial advice should be sought where appropriate. This website is free for you to use but we may receive commission from the companies we feature on this site.
David Waring

David Waring was the founder of LearnBonds.com and has been a major contributor to the extensive library of investing news and information available on the site. Until the launch of Learnbonds.com in late 2011 there was no single site on the internet catering exclusively to the individual bond investor. This was true even though more individuals own stocks than bonds. Learn Bonds was launched to fill that gap.

HTML Snippets Powered By : XYZScripts.com