Has the CD market become un-investable?

For most financial institutions, certificates of deposit have long been the bedrock for the investment side of the balance sheet. Given the Federal Deposit Insurance Corp. and National Credit Union Share Insurance Fund insurance coverage, ease of access and straight-forward analysis, it’s easy to understand why this would be. However, considering the outlook for the Fed funds rate and the influx of liquidity into financial institutions, we now see the CD market as un-investable for many institutions.

How do we find ourselves faced with an un-investable CD market? First, with the government insurance coverage provided on the first $250,000 on deposit at a financial institution, the CD market pays minimal credit spread above the risk-free rate (the rate when risk is zero). While CDs purchased through a brokerage firm are often assigned CUSIP numbers and have active secondary markets, CDs purchased directly from a financial institution are often less liquid and subject to early redemption penalties. As a result, direct placement CDs often receive some additional spread for the lack of liquidity. In either case, with the current forward guidance from the Fed that it plans to keep interest rates near zero for the next three to five years, the risk-free rate remains anchored within the current Fed funds target range of 0-0.25% for tenors (time to maturity) out to three years. Further out the yield curve, we see risk-free rates stuck below 1% at the 10-year tenor due to low inflation expectations.

 

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