The Impact of an Inverted Yield Curve and CD Rates

In a more turbulent interest rate economy, one of the most prevalent buzz words is ‘inverted yield curve’, yet many investors are not familiar with its meaning or its effects on their investment portfolio. While interest rate movements may not affect every investor directly, they can significantly impact the fixed income investor and in particular, those who are investing in CDs. Understanding what the yield curve is and how it can impact CD rates will help investors to make more educated decisions in regards to their personal investment portfolios.

What is an Inverted Yield Curve?

The yield curve describes a relationship between short and long term interest rates of US Treasury securities. But, how does inverted yield affect CD rates and other fixed interest rate investments? An inverted yield curve occurs when the short term interest rates exceed those of long term fixed securities. This phenomenon is an important economic event that impacts corporations, debt instruments, investors and consumers. And, investors should pay particular attention to this occurrence so that they may adjust their portfolios accordingly.

One of the reasons why this economic event is so significant is that it is out of the ordinary to have short term interest rates greater than long term rates. In many cases, when interest rates change in this fashion, it can signal an upcoming recession, causing many institutional investors to refinance their debt instruments; an event that affects individual investors and consumers alike.

What Does an Inverted Yield Curve Impact?

The most significant viewpoint of an inverted yield curve is that of a possible upcoming recession. When interest rates in the short term, including CD rates rise, it is an indication that the viewpoint of the long term health of the economy is poor. In an interest rate economy such as this, many investors move to shorter term debt instruments or CD rates that are more attractive while they search for more sustainable portfolio options for the long term.

How Does an Inverted Yield Curve Affect CD Rates Directly?

While an inverted yield curve can affect every investor, it has the greatest impact on the fixed income investors. When investors select CD rates that are for the longer term, they are generally doing so for the higher interest rates. Longer term fixed investment options pay a higher rate of return to compensate the investor for taking higher risks. In the event of an inverted yield curve, the shorter term CD rates such as the 1 year CD rates become more attractive than the 5 year CD rates. In the event that an investor has a variety of CD rates in their portfolio, it can become challenging to determine whether to move money into shorter term CDs for higher interest rates, to invest new money into the higher paying CDs or to leave the money in the existing portfolio for the long term. In any of these available options, it is always advised to seek the advice of a professional before making any investment decisions.