Why are CD rates so sporadic?

Question

I'm looking at CD rates for a popular online bank. I expected that the longer the term of the deposit, the higher the interest rate. But I was surprised to see that the rates are all over the place. Can anyone explain why there is such apparent randomness between these terms for otherwise identical accounts?

3 mo. 3%
6 mo. 5%
9 mo. 4.85
12 mo. 4.5%
18 mo. 4.25%
3 yr. 4.0%
5 yr. 3.90%

In particular, what makes a 6 month investment better for the bank than a longer or shorter one? What explains the lower rate as the term gets longer?

Answer 1

The rate for a given term is based on the market's expectation of short-term rates in the future. A bank will set the interest rate it pays based on the rates that it can earn on loans of similar amounts. They generally want to get more in loan interest than they pay in deposit interest (not withstanding teaser rates and loss-leaders).

What explains the lower rate as the term gets longer?

Interest rates right now are high compared to what they were for the last several years. Without going too much into the complexities of interest rate term structures, basically the market thinks that rates will stay high in the near term but go down in the long run. If the bank offered higher rates on long-term debt, it will probably be paying a higher rate in the future than it could make on its loans.

Banks must also compete against other banks for your deposits, so there's incentives to pay higher rates, but no so high that they lock themselves in to a rate that's higher than what they'll earn in loan interest. With shorter-term CDs they can take a little more risk since the lock period is shorter.

Loans are different - the rate for loans generally goes up as the term gets longer, mostly because the bank would have a hard time selling shorter term loan at higher rates when you could just set up a loan with a longer term and pay it off early. Plus the risk of default is higher at time goes on, so they charge higher rates for taking on extra risk with a longer loan.

Answer 2

Your issue is that you are looking at one bank. For more consistent results you may want to look at brokered CDs, bonds and T-Bills. These are sold (normally) in $1,000 increments, but some CDs allow $100 increments. Here is my result from Fidelity:

The fluctuations are quite different and in some cases the direction.

Answer 3

Looking at the rate list, you might think the obvious choice is to ignore the 5-year CD at 3.9%, and just get five 1-year CDs back-to-back at 4.5%. There certainly must be a reason why it's not always strictly superior to choose the investment with higher interest and more flexibility - the answer is that the scenario implies that the bank expects interest rates to go down in the future, meaning you likely won't have the opportunity to get a 1-year CD at 4.5% for each subsequent year.

If the bank expects interest rates to go down in the future, it does not benefit them to give you a high interest rate today which will be locked in for years to come. They'd prefer to give you a higher interest rate for a short period of time and then re-evaluate, or to lock you into a lower interest rate for a longer period of time.