Brokered CDs Offer an Attractive Alternative

Central banks around the world are lowering interest rates, causing the short-term yields in the U.S. to exceed long-term yields. Brokered CDs offer the highest, most secure yields with 1 to 5-year maturities.

Both Germany and China are using interest rates and currency levels to control their respective economies relative to the US economy, and therefore reducing the price of their exports, and increasing the price of their imports. However, only a low, followed by an increase in the German Bund has forecast the low in the US 10-year T-Note. The level of the Chinese yuan relative to the U.S. dollar also affects changes in the world economy. The highest valuation of the yuan at 6.3 coincided with the peak in the German 10-year Bund yield in 2018, while the devaluation to 7.05 in August 2019 is concurrent with the low German yield (see Chart I).

Chart I

The Chinese yuan weakened, breaking an important level of 6.9 on Monday, August 5th, reaching an intraday low 7.13 to the US dollar, which led to the U.S. declaring that China is manipulating its currency to gain an unfair advantage in trade. This extreme depreciation has been seen in the past, when the Chinese yuan traded at 8 from 1995 to 2008. The depreciation of the yuan has increased the cost of exports from Germany and the US, as well as the rest of the world, while reducing cost of China’s exports. Today, Germany’s heavy reliance on trade at 47% of GDP is the greatest in Europe. It is estimated that Germany exports $21,000 of goods and services for each of its citizens. The comparable figure for France, the eurozone’s second-largest economy, is $12,388. For the U.S., it’s $6,800.1

Germany is experiencing negative growth in manufacturing and exports, causing their central banks to reduce yields on the German Bund to a negative 86 basis points on the 2-year and a negative 58 basis points on the 10-year. This decline in German yields resulted in a drop in the benchmark 10-year U.S. Treasury note to an intraday low of 1.59% as of June 7th. Recently, the Federal Reserve reduced the Fed Funds Rate to 2%. All this continues to weigh on U.S. bank profitability.

The German 2-year yield at a negative 86 basis points approaches the low yield witnessed in 2017, so the good news is German rates are likely at or near their lows. A resolution to the imbalance of trade that has favored China and Germany would provide the opportunity for future growth in world exports and a return to positive German interest rates (see Chart II).

Chart II

US Nominal GDP Influence Over 10-Year Yields

US 10-year T-Note yields normally reflect nominal US GDP growth. As an example, the acceleration in nominal US GDP from 3% to almost 6% under the Trump administration increased the US 10-Year T-Note yield from around 2% to over 3%. However, this decline in the German 10-year Bund since the beginning of 2018 has led to a decline in the US 10-year from over 3% to under 1.7%.

World economic weakness was also reflected in US nominal GDP growth declining from 5.5% to under 4% in the second quarter of 2019, and US 10-year yields declining below 2%. However, the decline in US yields is expected to result in a recovery of nominal GDP growth to 5% (given 3% real GDP and 2% inflation) by year-end 2021, potentially increasing 10-year U.S. yields toward 3% (see Chart III).

Chart III

Bank Profitability

The main drivers of bank profitability are (1) lending rates and (2) deposit costs. Loan rates are primarily driven by the 10-year T-Note yield and its impact on mortgage rates and business lending. The 10-year T-Note yield fell from over 3.0% to 1.7% due to the sharp decline in German 10-year yields from a positive 50 basis points to a negative 58 basis points. On the other hand, deposit costs are held up by a 3-month T-Bill yield of 2.0% due to a Federal Funds rate of 2.0% (see Chart IV).

Bank profitability will benefit from another reduction in the Federal Funds rate in September 2019 to 1.75%, followed by a further reduction in October to 1.50%. The low in the US 10-year T-Note yield of under 1.7% seems assured to rise above 2% if the German 2-year rebounds from a negative 86 basis points, like the low-then-recovery seen in 2017 (see Chart II).

Chart IV

CD Rates Remain Attractive

Brokered CDs under $250,000 with yields above the Federal Funds rate, government guarantees and maturities in the 1 to 5-year range offer an attractive fixed-income alternative. Currently, the U.S. yield curve is inverted due to the ongoing attempts to depreciate currencies by Germany, Japan and China. Given the expectation of a continued U.S. economic growth and a positive resolution to the U.S.- China trade negotiations, U.S. 10-year yields should recover, rising toward 3% by 2021, and for principal safety and best yield, brokered CDs under $250,000 offer the best alternative.

Each quarter, IDC Financial Publishing (IDCFP) tracks and provides a forecast of outstanding balances of brokered CDs less than $250,000. The number of institutions issuing brokered CDs, as well as outstanding CDs issued, has grown at an accelerated rate in recent years, and we project this trend to continue.

1 - Wall Street Journal article, published July 24, 2019 https://www.wsj.com/articles/europe-gets-caught-in-the-u-s-china-crossfire-11563980001?mod=searchresults&page=1&pos=5

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John E Rickmeier, CFA, President, jer@idcfp.com

Robin Rickmeier, Marketing Director