generic question - why CDs and Treasury notes differ in rates

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helloeveryone
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generic question - why CDs and Treasury notes differ in rates

Post by helloeveryone »

I have a very generic broad question. Why is it that CD's and Treasury notes different in their yield.
I'm studying fixed income options. And at vanguard I see that currently there are 2 year vanguard brokerage cd's that have 5.15% annualized yield, and there are 2 year treasury notes that have 4.538% yield.

Thanks! Just trying to understand fixed income things. Not in market for them. I'm a 2 fund portfolio person (S&P500 and Vanguard Total Bond) and am not anywhere near retirement where I would consider these options.
z3r0c00l
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Re: generic question - why CDs and Treasury notes differ in rates

Post by z3r0c00l »

Lots of differences including:

CDs are sold primarily to individuals, they are not available in the billions of dollars of daily liquidity that companies and governments need. So when you buy treasuries, you are buying alongside auctions of billions of dollars, including buyers who must buy something, like pension funds, insurance companies, and governments. I think these gigantic obligate buyers allow the US government to borrow money at pretty cheap rates.

CDs may be callable, have early withdrawal penalties, and generally will stop paying interest if you cash them out. They can't always be sold either. The money is effectively locked up for longer in this case, since you can't sell or break the CD without some cost. Treasury bonds always have willing buyers in a liquid market. You might even make money selling a treasury bond early if interest rates have dropped.

CDs may be sold by banks who are eager to get your money, and may use teaser rates such as abnormally high 7 month CDs which then roll over into much lower rates on 6 month CDs.

This is not a particularly normal yield environment as the government is actively tinkering with the yield curve to try and fight inflation. There are lots of strange things going on right now, like my zero volatility money market fund paying 1% more than 30 year treasuries which are more like stocks in daily volatility. It doesn't make much sense, but it is really happening.

A non-callable 2 year CD paying 5.15% sounds pretty solid if that is what you are looking at.
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billaster
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Re: generic question - why CDs and Treasury notes differ in rates

Post by billaster »

Banks can borrow from depositors at 5.15% and lend to home buyers at 7.5%. The assets have different time spans but that has been the historical job of banks for hundreds of years -- borrow short and lend long. Providing the intermediation between depositors who need short term liquidity and borrowers who need long term loans is a primary function of banks. They make their profit on the spread.
alex_686
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Re: generic question - why CDs and Treasury notes differ in rates

Post by alex_686 »

Hot Money.

Treasuries are the safest, most liquid bond out there.

CDs are corporate debt. Yeah, I mean they are a special type of corporate debt - corporate debt issued by banks, insured by the FDIC, and pretty high up in the debt structure. It may be a wee bit more operationally friendly to the small retail investor. Treasuries don't offer death puts. But still, in the end, corporate debt.

With that in mind, realize that only banks that need to raise new funding go out and issue brokerage CD. These banks tend to be desperate. After all if their deposit base was healthy they wouldn't be shrilling their bonds and paying Vanguard a slice of the pie.

Hence the term, "Hot Money". Banks need to entice liquid investor to pony up and buy their bonds, and obviously the average broker investor only cares about the CD that offers the highest rate.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Thesaints
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Re: generic question - why CDs and Treasury notes differ in rates

Post by Thesaints »

The main drivers in yield difference are the fact that treasuries are state tax exempt and, primarily, the different credit rating between the USofA and a private bank.
Yet, under the FDIC limit CD are just as safe as Treasuries and that is one of the few cases in which the small fish as an advantage over the big ones.
snic
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Re: generic question - why CDs and Treasury notes differ in rates

Post by snic »

alex_686 wrote: Tue Apr 02, 2024 7:42 pm Hot Money.

Treasuries are the safest, most liquid bond out there.

CDs are corporate debt. Yeah, I mean they are a special type of corporate debt - corporate debt issued by banks, insured by the FDIC, and pretty high up in the debt structure. It may be a wee bit more operationally friendly to the small retail investor. Treasuries don't offer death puts. But still, in the end, corporate debt.

With that in mind, realize that only banks that need to raise new funding go out and issue brokerage CD. These banks tend to be desperate. After all if their deposit base was healthy they wouldn't be shrilling their bonds and paying Vanguard a slice of the pie.

Hence the term, "Hot Money". Banks need to entice liquid investor to pony up and buy their bonds, and obviously the average broker investor only cares about the CD that offers the highest rate.
Um, recently I saw brokered CDs from JP Morgan Chase, Wells Fargo, and a few other well-established banks that aren't exactly hurting for depositors.

You're forgetting that people and institutions who buy brokered CDs are depositors. Sure, the bank has to pay the broker a cut, but in exchange, they don't have to hassle with dealing with you as a retail customer - no account applications to keep track of, no customer service agents to handle your calls, no customer online account they have to maintain and keep secure, etc, etc. And on top of that, many brokered CDs are callable, whereas most retail CDs are not - so if the bank wants to issue callable CDs, there's pretty much only one way to do that.
alex_686
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Re: generic question - why CDs and Treasury notes differ in rates

Post by alex_686 »

snic wrote: Tue Apr 02, 2024 8:42 pm
alex_686 wrote: Tue Apr 02, 2024 7:42 pm Hot Money.

Treasuries are the safest, most liquid bond out there.

CDs are corporate debt. Yeah, I mean they are a special type of corporate debt - corporate debt issued by banks, insured by the FDIC, and pretty high up in the debt structure. It may be a wee bit more operationally friendly to the small retail investor. Treasuries don't offer death puts. But still, in the end, corporate debt.

With that in mind, realize that only banks that need to raise new funding go out and issue brokerage CD. These banks tend to be desperate. After all if their deposit base was healthy they wouldn't be shrilling their bonds and paying Vanguard a slice of the pie.

Hence the term, "Hot Money". Banks need to entice liquid investor to pony up and buy their bonds, and obviously the average broker investor only cares about the CD that offers the highest rate.
Um, recently I saw brokered CDs from JP Morgan Chase, Wells Fargo, and a few other well-established banks that aren't exactly hurting for depositors.

You're forgetting that people and institutions who buy brokered CDs are depositors. Sure, the bank has to pay the broker a cut, but in exchange, they don't have to hassle with dealing with you as a retail customer - no account applications to keep track of, no customer service agents to handle your calls, no customer online account they have to maintain and keep secure, etc, etc. And on top of that, many brokered CDs are callable, whereas most retail CDs are not - so if the bank wants to issue callable CDs, there's pretty much only one way to do that.
What makes you think that JP Morgan Chase, Wells Fargo, et. al. don't need money? The funding needs of a bank are dynamic. They may have had a few months were the sold above plan car loans and credit cards but sold deposit accounts below plan.

On your second part you have things backwards - but it is a subtle thing. Retail clients tend to be sticky. They tend not to shop around for rates. They tend to roll over CDs. This matters for 2 reasons.

First, normally, retail CDs have a lower interest rate. Note, when comparing rates please factor in the option adjusted spread for the CD's put option.

Secondly, and more critically, brokerage CDs have a higher discount rate than retail CDs for Liquidity Coverage Ratio (LCR) ratios. The calculations that determine if a bank is a going concern by the Federal Reserve. This is a BASEL III thing to prevent a run on the funding side like Northern Rock back during the Great Financial Crisis. It is considered to be much less stable for funding purposes. This really outweighs your concern.

FYI, I have been on both sides of the transaction.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Geologist
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Re: generic question - why CDs and Treasury notes differ in rates

Post by Geologist »

alex_686 wrote: Tue Apr 02, 2024 8:55 pm
snic wrote: Tue Apr 02, 2024 8:42 pm
alex_686 wrote: Tue Apr 02, 2024 7:42 pm Hot Money.

Treasuries are the safest, most liquid bond out there.

CDs are corporate debt. Yeah, I mean they are a special type of corporate debt - corporate debt issued by banks, insured by the FDIC, and pretty high up in the debt structure. It may be a wee bit more operationally friendly to the small retail investor. Treasuries don't offer death puts. But still, in the end, corporate debt.

With that in mind, realize that only banks that need to raise new funding go out and issue brokerage CD. These banks tend to be desperate. After all if their deposit base was healthy they wouldn't be shrilling their bonds and paying Vanguard a slice of the pie.

Hence the term, "Hot Money". Banks need to entice liquid investor to pony up and buy their bonds, and obviously the average broker investor only cares about the CD that offers the highest rate.
Um, recently I saw brokered CDs from JP Morgan Chase, Wells Fargo, and a few other well-established banks that aren't exactly hurting for depositors.

You're forgetting that people and institutions who buy brokered CDs are depositors. Sure, the bank has to pay the broker a cut, but in exchange, they don't have to hassle with dealing with you as a retail customer - no account applications to keep track of, no customer service agents to handle your calls, no customer online account they have to maintain and keep secure, etc, etc. And on top of that, many brokered CDs are callable, whereas most retail CDs are not - so if the bank wants to issue callable CDs, there's pretty much only one way to do that.
What makes you think that JP Morgan Chase, Wells Fargo, et. al. don't need money? The funding needs of a bank are dynamic. They may have had a few months were the sold above plan car loans and credit cards but sold deposit accounts below plan.
We can throw in Bank of America, Morgan Stanley, and Goldman Sachs (just from perusing Vanguard's brokered CD list this evening).

However, if banks like this need money and are therefore "desperate" (your word), then all banks in the US are desperate and the word desperate has no meaning.
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nisiprius
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Re: generic question - why CDs and Treasury notes differ in rates

Post by nisiprius »

The basic answer is that FDIC-insured CDs that an ordinary retail customer buys at a bank are really in a different marketplace from Treasury notes. They don't really compete against each other, so the rates don't track closely. The issues of whether a particular bank needs deposits are complicated, too.

Of course there are exceptions, but if my spouse wants to get a CD at a bank, she will be comparing the rates against other CDs at banks. She isn't going to say "I think I'll buy a Treasury note instead."

You may say "It's not actually that hard to buy a Treasury note," and it isn't. (I've done it myself in the 1970s by physically walking into the physical building of a Federal Reserve bank, finding the right room on the right floor, filling out a form, and presenting it with a check). Even so, I would guess that less than 1% of the general public have ever done it. "Nobody" (i.e. only a very few people) think of Treasury notes as CD alternatives.
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snic
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Re: generic question - why CDs and Treasury notes differ in rates

Post by snic »

alex_686 wrote: Tue Apr 02, 2024 8:55 pm
snic wrote: Tue Apr 02, 2024 8:42 pm
alex_686 wrote: Tue Apr 02, 2024 7:42 pm Hot Money.

Treasuries are the safest, most liquid bond out there.

CDs are corporate debt. Yeah, I mean they are a special type of corporate debt - corporate debt issued by banks, insured by the FDIC, and pretty high up in the debt structure. It may be a wee bit more operationally friendly to the small retail investor. Treasuries don't offer death puts. But still, in the end, corporate debt.

With that in mind, realize that only banks that need to raise new funding go out and issue brokerage CD. These banks tend to be desperate. After all if their deposit base was healthy they wouldn't be shrilling their bonds and paying Vanguard a slice of the pie.

Hence the term, "Hot Money". Banks need to entice liquid investor to pony up and buy their bonds, and obviously the average broker investor only cares about the CD that offers the highest rate.
Um, recently I saw brokered CDs from JP Morgan Chase, Wells Fargo, and a few other well-established banks that aren't exactly hurting for depositors.

You're forgetting that people and institutions who buy brokered CDs are depositors. Sure, the bank has to pay the broker a cut, but in exchange, they don't have to hassle with dealing with you as a retail customer - no account applications to keep track of, no customer service agents to handle your calls, no customer online account they have to maintain and keep secure, etc, etc. And on top of that, many brokered CDs are callable, whereas most retail CDs are not - so if the bank wants to issue callable CDs, there's pretty much only one way to do that.
What makes you think that JP Morgan Chase, Wells Fargo, et. al. don't need money? The funding needs of a bank are dynamic. They may have had a few months were the sold above plan car loans and credit cards but sold deposit accounts below plan.

On your second part you have things backwards - but it is a subtle thing. Retail clients tend to be sticky. They tend not to shop around for rates. They tend to roll over CDs. This matters for 2 reasons.

First, normally, retail CDs have a lower interest rate. Note, when comparing rates please factor in the option adjusted spread for the CD's put option.

Secondly, and more critically, brokerage CDs have a higher discount rate than retail CDs for Liquidity Coverage Ratio (LCR) ratios. The calculations that determine if a bank is a going concern by the Federal Reserve. This is a BASEL III thing to prevent a run on the funding side like Northern Rock back during the Great Financial Crisis. It is considered to be much less stable for funding purposes. This really outweighs your concern.

FYI, I have been on both sides of the transaction.
I didn't say those banks don't need money. I said I don't think they (among the largest banks in the US) are hurting for depositors. Which was in response to your assertion that banks that issue brokered CDs "tend to be desperate". It comes as a surprise to me that Chase and WFB are desperate. But I'm not an insider, I have no idea - maybe we should be worried about them?
alex_686
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Re: generic question - why CDs and Treasury notes differ in rates

Post by alex_686 »

Geologist wrote: Tue Apr 02, 2024 9:03 pm We can throw in Bank of America, Morgan Stanley, and Goldman Sachs (just from perusing Vanguard's brokered CD list this evening).

However, if banks like this need money and are therefore "desperate" (your word), then all banks in the US are desperate and the word desperate has no meaning.
eh. I will take the more pragmatic approach here. Absolutes won't work. Different types of funding for banks have different advantages and disadvantages. Having a heterogenous funding mix is a benefit. Ask Silcon Vally Bank.

A interesting research project would be to compile amount of CDs issued weekly over a 5 year period by the major banks. You will find periods of low or even no issuance.

Then compare the funding mix over that period.

Then think about the funding costs. It is cheaper to issue small dollar amounts of CDs because you don't have to issue audited registered prospectus like you do with bonds.

When smaller banks pop up they tend to be more desperate.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
snic
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Re: generic question - why CDs and Treasury notes differ in rates

Post by snic »

nisiprius wrote: Tue Apr 02, 2024 9:05 pm The basic answer is that FDIC-insured CDs that an ordinary retail customer buys at a bank are really in a different marketplace from Treasury notes. They don't really compete against each other, so the rates don't track closely. The issues of whether a particular bank needs deposits are complicated, too.

Of course there are exceptions, but if my spouse wants to get a CD at a bank, she will be comparing the rates against other CDs at banks. She isn't going to say "I think I'll buy a Treasury note instead."

You may say "It's not actually that hard to buy a Treasury note," and it isn't. (I've done it myself in the 1970s by physically walking into the physical building of a Federal Reserve bank, finding the right room on the right floor, filling out a form, and presenting it with a check). Even so, I would guess that less than 1% of the general public have ever done it. "Nobody" (i.e. only a very few people) think of Treasury notes as CD alternatives.
Yeah, but the OP was asking about brokered CDs, which are marketed to people and institutions who could very well also consider treasuries. Treasuries and brokered CDs are just one tab apart on the Fidelity website.
alex_686
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Re: generic question - why CDs and Treasury notes differ in rates

Post by alex_686 »

snic wrote: Tue Apr 02, 2024 9:09 pm I didn't say those banks don't need money. I said I don't think they (among the largest banks in the US) are hurting for depositors. Which was in response to your assertion that banks that issue brokered CDs "tend to be desperate". It comes as a surprise to me that Chase and WFB are desperate. But I'm not an insider, I have no idea - maybe we should be worried about them?
Probably not.

Brokerage CDs tend to be the most expensive funding source. Maybe.

Lets say I am at the Monday meeting in a bank's corporate treasury. We want to increase our funding by $100m. The cheapest way is to increase our deposit base. If you ignore marketing costs, which is expensive. Plus it takes time. Plus it is uncertain. But once you get the depositor in the door they tend to stay. The most expensive is to issue new equity and that takes time. The second most expensive tends to be brokered CDs. However I can get those funds in 2 weeks with a high degree of certainty.

Sometimes it is a little from A and a little from B.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
alex_686
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Re: generic question - why CDs and Treasury notes differ in rates

Post by alex_686 »

One last prospective.

When a corporation issues a bond they go on a "road show". They stop by investors and pitch their bond. There is a negotiation on the rates and terms.

With broker CDs you price them to sell. You are a price taker, not a price setter. And you keep on selling them until you hit your goal.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Topic Author
helloeveryone
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Re: generic question - why CDs and Treasury notes differ in rates

Post by helloeveryone »

Thank you for all the responses. Very good insight and differing perspectives. Perusing the fixed income section of vanguard was pretty cool, helpful to do now and understand it especially having read some posts about CD ladders that have come up during these higher interest rates times.
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