Often times, CDs can experience unique patterns in their interest rates, representing normal, inverted, or flat yield curves. The type of curve the market experiences depends largely on the economy; however, flat yield curves usually represent a transition between the other two types. Let’s look more closely at just what this type of curve means to you.
The Definition of the Yield Curve
The yield curve is a representation of the direction that interest rates are moving in relation to short-term and long-term investment securities. To understand this concept, you would need to understand how interest rates are typically assigned to securities, and in this case, CDs. In what would be considered a normal yield curve, you will find that a short-term investment (ex. 6-month CDs) offers a lower interest rate than a long-term investment (ex. 5-year CD). This is kind of a reward for depositing your money (with no access to it) for a longer period of time.
However, if the economy has weakened, you may see the yield curve move in the opposite direction. In other words, the lower interest rate may be assigned to the long-term investment. This is called an inverted yield curve and occurs because the market is unsure of the likelihood that investors will want to participate in a weak economy, and thus decides to protect itself from a weak market.
Why the Yield Curve Goes Flat
So you’re probably wondering then when you’ll see flat yield curves. They occur during the transition from normal to inverted, or vice versa. During the time that the curve has flattened, the interest rates of both short- and long-term investments are pretty similar. For some, this period signals a temptation to invest all funds in short-term CDs to take advantage of potentially higher rates, and be able to get in and out quickly. However, experts usually advice against this strategy because this time period represents instability. So if you’re looking to make long-term investments, instead of putting everything in short-term CDs to enjoy the higher rate, you may just want to wait until you see a normal yield curve again.
CDs are highly impacted by all yield curve activity – flat yield curves are no exception. So if you notice instability such as this in the market, you may want to seek expert advice before moving forward with your investment.