CD Rates so much higher than bonds?

[dandan14]

I know that Allan Roth often promotes the strategy of buying CDs over bonds -- and there are some good reasons for that. (You can typically cash out for a low penalty if rates go way up.) On the secondary market, you lose that benefit, and they behave much more like bonds. For that reason, I typically hold CDs for about half of my fixed portfolio.

Here's my question. For mid-term bonds (let's say 10 years from now), US Treasuries are paying about 2.26 as of today.

There is a new issue from JP Morgan chase (8/16/17) for 10 years paying 2.8%. It is reasonably in line with others with that maturity.

I'm trying to justify to myself why the market adds so much of a premium to the price of bonds (thus lowering their rates).
Thoughts? Ideas?

[aristotelian]

The market thinks JPM rskier than the US government.

[Thesaints]

Not sure I understand. Treasuries are, well, treasuries and FDIC insurance does not work with real money.

[dandan14]

I guess the 250k fdic limit would keep out institutional money.

[badger42]

Treasuries are also just about perfectly liquid, where you'll take a decent haircut if you have to sell a brokered CD before maturity.

Also, if rates fall, it's far easier to take profits on treasuries.

[grok87]

agree with both badger and dandan

[alex_686]

I guess the 250k fdic limit would keep out institutional money.

You have nailed the issue on the head. This is why CDs pay out more than treasuries.

On a slightly different track, I think of CDs as bonds with a put feature.

[grok87]

On a slightly different track, I think of CDs as bonds with a put feature.

this is sort of true with regular CDs. Even then i think this put feature "ain't what it used to be" as early withdrawal penalties have become more punitive. Also there is no guarantee in general of being able to withdraw early. it depends on the terms and conditions. Most banks have language that says they have the right to refuse early withdrawals. Many folks think that if rates really spike then banks will exercise that right.

but my guess is that the OP's CD is NOT a regular CD but a brokered CD. In that case there is no early withdrawal option whatsoever, ie no put option. You just would sell it if you want your money back, same as a regular bond.

[willthrill81]

I know that Allan Roth often promotes the strategy of buying CDs over bonds -- and there are some good reasons for that. (You can typically cash out for a low penalty if rates go way up.) On the secondary market, you lose that benefit, and they behave much more like bonds. For that reason, I typically hold CDs for about half of my fixed portfolio.

Here's my question. For mid-term bonds (let's say 10 years from now), US Treasuries are paying about 2.26 as of today.

There is a new issue from JP Morgan chase (8/16/17) for 10 years paying 2.8%. It is reasonably in line with others with that maturity.

I'm trying to justify to myself why the market adds so much of a premium to the price of bonds (thus lowering their rates).
Thoughts? Ideas?

In the current environment of rising rates, I wouldn't lock up any money at a fixed 2.8% for ten years unless I was in retirement and it was part of a CD ladder, the tenth year of spending being the very last rung of the ladder.

[Valuethinker]

I know that Allan Roth often promotes the strategy of buying CDs over bonds -- and there are some good reasons for that. (You can typically cash out for a low penalty if rates go way up.) On the secondary market, you lose that benefit, and they behave much more like bonds. For that reason, I typically hold CDs for about half of my fixed portfolio.

Here's my question. For mid-term bonds (let's say 10 years from now), US Treasuries are paying about 2.26 as of today.

There is a new issue from JP Morgan chase (8/16/17) for 10 years paying 2.8%. It is reasonably in line with others with that maturity.

I'm trying to justify to myself why the market adds so much of a premium to the price of bonds (thus lowering their rates).
Thoughts? Ideas?

Your correct comparison would be a deposit at JPM vs. a bond issued by JPM. But the latter would have various complications (ranks behind deposits on sale/ liquidation, illiquid, possible call provision).

Deposits are "stickier" than money markets for banks-- a readier source of cash if there is an illiquidity crisis a la Q4 2008, when the Money Markets shut down. The holders just don't switch as fast.

So regulators favour them, and banks try to get more deposits.

The FDIC limit allows the small saver to get a US government credit rating on a CD issued by a private institution. Large investors can't do that-- if they want totally safe assets, they have to go for US Treasury bonds.

One of the few cases where the individual investor does better than the institutional investor.

[grok87]

Another thing that has not been mentioned yet is state taxes. With cds you pay it with treasuries you don't.
Obviously only relevant for investments in a taxable account

Let's say someone pays 10% state tax and assume the OP's cd is a brokerage one. Then the 2.8% nets to 2.52% or 26 bps more than the treasury. The question then is whether that 26 bps is sufficient compensation for the illiquidity of the cd. For me it would be a close call. I'd probably want more like 50 bps.

[rmelvey]

In a retirement account where you are confident you will hold to maturity the CD is probably the smarter choice. In a taxable account I would go with the treasury due to lower taxes and the ability to easily sell it if I end up needing the money. One of bonds greatest features is liquidity and with CDs you lose some of that.

[Engineer250]

Another thing that has not been mentioned yet is state taxes. With cds you pay it with treasuries you don't.

I don't know much of anything about treasuries. Is this true if you own a treasury fund or do you have to own treasuries directly for this to be true?

[dodecahedron]

Another thing that has not been mentioned yet is state taxes. With cds you pay it with treasuries you don't.

I don't know much of anything about treasuries. Is this true if you own a treasury fund or do you have to own treasuries directly for this to be true?

Some state and local governments prorate their income tax exemption based on the percentage of a mutual fund's income attributable to interest on US Treasury securities held by the fund. Some states with personal property taxes on intangible assets, prorate an exemption based on the percentage of assets invested in US Treasury obligations. Exact details differ from state to state: for example, in my state (NY), I get no state income tax exemption at all unless at least 50% of the mutual fund's assets are invested in US Treasury obligations, but once that asset test is satisfied, I can prorate the exemption based on the percentage of the fund's income coming from US Treasury interest payments.

Mutual fund sponsors issue a statement at the end of each year showing the proportion of US Treasury income and assets. Here, for example, is Vanguard's statement:

https://docs.google.com/viewer?url=http ... 022017.pdf

[best2u]

My experience with CDs, which is limited to purchasing some brokered CD s via Vanguard and a few directly from local financial institutions is that the 2.8% rate is a respectable offering for today's market, if the CD is not callable. If call risk is accepted there could be some offerings in the 3 to 3.2% range available out there in the secondary market . Do check your local financial institutions as they offer some attractive specials from time to time. New issue CD offerings non callable have been running 2.6 to 2.75 at Vanguard. Secondary market 15 basis points higher. Hope this helps.