Unlike compact discs, the other CDs in fixed-income format–certificates of deposit–could be poised for a comeback. With current investor sentiment in a risk-on mode, capital allocations to CDs have fallen to the wayside, but CD rates have been on the move, climbing to as high as 3% at certain online banks versus their brick and mortar counterparts.
In the past month, the floodgates have opened to positive news regarding the economy, such as the Commerce Department announcing a 4.1% increase in gross domestic product during the second quarter. In addition, unemployment has been relegated to generationally-low levels in conjunction with a raging bull market where the major market indexes are all eyeing record-highs.
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With all signs pointing to a robust economy, it sets the stage for Federal Reserve Chairman Jerome Powell to announce more interest rate hikes in September in addition to the pair of rate hikes already seen this year. CDs have been beneficiaries of these rate hikes with banking institutions like Citizens Access and PurePoint Financial offering 3% rates on three-year terms.
“We’ve been in a very low-rate environment for close to 10 years,” said Anthony Ogorek, CEO of Ogorek Wealth Management. “People begin to think that is a normal course of affairs. So when they see rates at maybe 1.5, 2, 2.5 percent, they might jump at that and think it’s the highest rate in close to a decade.
“But you have to look at rates relative to inflation, and the rates that you’re receiving at the bank right now are truly nothing to write home about,” he said.
Online Banks Offering Higher Rates
One area in particular where CD rates have seen a noticeable uptick is in online banks. Unlike the traditional brick-and-mortar banks, online banks do not have the operational costs associated with branches like Bank of America or Wells Fargo.
Traditional banks build their business models around customer retention and convenience rather than trying to attract new prospects based on higher interest rates. Online banks, however, can bypass the operating costs necessary for traditional banks and offer higher rates on their products like CDs.
In a rising rate environment, the tough sell for CDs will be that the a lack of a floating rate component and slow adjustments won’t allow investors to capitalize on short-term rate increases. Despite this, risk-averse investors can take advantage of CDs if the inherent volatility spikes of stocks or other asset classes are too much to endure.
“Banks tend to move rates up fairly slowly,” he said. “Just because the Fed is increasing rates, you’re not going to see much of an increase in what a bank is offering right now.”
For more trends in fixed income, visit the Rising Rates Channel.