# Why so much joy about higher CD rates?

I think I’ve discussed this before in various replies, but haven’t yet begun a separate post for it. So let’s start the conversation here.

Why are people so overjoyed about higher CD rates? Seems to me, that the true real yield is now LOWER than ever. I’ll explain. When inflation was 2% and CDs yielded 0.05%, your net real yield was about -1.965% (0.05% - 2.00% CPI - 0.015% of income tax). Now with CDs hitting 3-4%, your net real yield is about -5.2% (4% - 8% CPI - 1.2% of income tax)!

How is that a reason to celebrate??!!!???

Even if inflation trends down to 5% over the next year, and you’ve locked in some 4% CDs, your real yield will be -2.2% (4% - 5% CPI - 1.2% tax) which is STILL worse than it was during all those years we lamented “zero” interest rates.

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I think it’s a case of “Been Down So Long it Looks Like Up To Me” (
Richard Fariña
).

You can currently get approximately 3% (2.88-31 that I’ve seen) for cash at most brokers, so tying up funds for years in 3% CD when interest rates are expected to rise is a little puzzling.

Jeff

This is, of course, a different question. If rational people are willing to tie up their money in a 3% CD, say for 5 years, they must rationally expect that average cash rates (money market, online savings, 4-week treasury bills, etc) over the 5 year period will be less than 3%.

My question can be expanded to “Why so much joy over higher cash and CD rates?” The same simple arithmetic that I illustrated above applies to both.

I’m not “overjoyed” at higher CD rates. Since retiring, I’ve always kept 5+ years of withdrawals in fixed income. The rates have been abysmal,lol, but the principal does not evaporate like stock prices occasionally do. I’ll be shifting into T-notes as CD’s come due. These yield slightly more than CD’s, with a small chance that the value of the note will go up, if inflation gets under control and the Fed cuts interest rates.

To me, having money in fixed income is a known loser, but there is no alternative. Will not have everything tied up in stocks.
( just to note, I’m not a nervous-nellie, I have not bailed out of stocks, and the fixed-income reserves are why I’m not sweating it, so far anyways )

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And if that is higher than the money markets (which it currently is), then it is a reason to be happy. The primary reason for a money market or a CD is return of capital. The return on investment is nice but only icing. And while it might be lagging inflation, it is lagging less than the alternatives.

Put another way, where else would you be putting this money if not the CDs?

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I am not discussing where to invest cash, putting ones cash into CDs is clearly rational for many people. Especially those who believe they can get a higher average rate over the term (5 years of 3% beats one year of 4%, plus one year of 3%, plus two years of 2%, plus one year of 1%), or people that don’t want to deal with moving money around to chase yield.

I am discussing the level of jubilation I see today compared to a year ago regarding short-term interest rates. A year ago, everyone was dour about short-term rates at about 0 percent nominal, with a real yield of about -2 or -3 percent. But today, there is palpable joy among many with short-term rates at 3 or 4 percent nominal, but real (after income tax) rates at about -4 or -5 percent. Net net, short-term fixed income investments are WAY worse off today than a year ago.

The only thing I can conclude is that 40 years of low inflation, and low rates, have lulled us (“us”) into thinking mostly in terms of nominal rather than real rates. Meanwhile, real rates are the only thing that really matters, in both the short term and especially in the long term.

Or that people have lower expectations for future intermediate term inflation rates. If you think that the Fed will be successful in taming inflation within a year or so, then that 3% rate on a five-year instrument is going to crush that real yield of -2 or -3 percent.

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