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It was a week of unprecedented volatility on deposits as nearly 60 percent of institutions cut CD yields. Certificate of deposit yields were down a pretty even 25 basis points across the board after the Fed cut short-term rates by half a percent (50 basis points).
Long-term yields have been steadily declining since September as it became apparent the Fed was done raising rates and that rate cuts were likely as the economy continued to slow. Long-term yields tend to fall further and faster leading up to a rate cut as institutions try to limit their exposure to paying above-market yields long into the future.
Only as reports of slowing sales and production and repeated corporate profit warnings surfaced with increasing regularity in the fourth quarter of 2000 did short-term yields begin a slow retreat. However, the surprise 50 basis point Fed cut on Jan. 3 was the impetus that brought both shorter-term and longer-term yields down uniformly.
Three-month CD yields weren't down as sharply as other maturities, just as they don't increase as significantly in rising rate environments. The real yield premium for locking up funds in a CD starts to kick in at maturities of six months. As a result of this lower nominal yield, there is reduced volatility on a three-month CD relative to other maturities.
With the likelihood of further rate cuts in the first half of this year, the downward trend is likely to sustain itself. Is there a silver lining to this cloud? As inflation remains stable or even declines, the declining yields will not completely erode an investor's real return.
However, any uptick in inflation amid declining yields, whether from energy prices or oil prices, will serve as a double-whammy in reducing the real, or after-inflation, rate of return.
The timing of the Fed's move to cut rates in hopes of abating a breakneck slowdown seems particularly fortuitous for homeowners with variable-rate home equity lines of credit (HELOCs). Lenders reprice many of their loan products that are tied to the prime rate, such as HELOCs, on varied schedules. While some may do so immediately, others may do so monthly, or quarterly.
The timing of this rate cut could have impacted many institutions that reference the prime rate as published in The Wall Street Journal the first Monday of each month or quarter when repricing. Since Jan. 1 was a holiday, Monday, Jan. 8 was the first business Monday of the month and quarter and the lower prime rate of 9 percent could well have come into play. Inconceivable? The national average for HELOCs dropped 29 basis points this week, the largest weekly drop since being added to the national survey in 1992.
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