If you’ve noticed that 6-month or 1-year CDs often pay higher APYs than 5-year CDs, you are observing an economic phenomenon known as an inverted yield curve.
Here is what every smart American saver needs to know about how the Federal Reserve drives CD interest rates.
How the Fed Funds Rate Dictates Bank APYs
Commercial banks set their CD rates based on the Federal Funds Rate—the target interest rate determined by the Federal Open Market Committee (FOMC).
- When the Fed raises rates to combat inflation, commercial banks must compete for cash deposits, causing CD APYs to surge.
- When the Fed lowers rates to stimulate economic growth, banks cut CD rates quickly to reduce their cost of borrowing.
Why Are Short-Term CDs Sometimes Higher than Long-Term CDs?
In a standard economic climate, longer terms (3 to 5 years) offer higher yields because you take on more time risk. However, when financial markets anticipate that the Federal Reserve will cut interest rates in the near future:
- Banks offer higher promotional rates on 6-month to 12-month CDs because they only have to pay that elevated rate for a short time.
- Banks offer slightly lower rates on 5-year CDs because they do not want to be locked into paying high interest if benchmark rates fall to 2% or 3%.
How Savers Should Position Their Cash
To avoid locking money into the wrong term length:
- Compare Offers: Use our CD Comparison Calculator to see if the higher APY on a 6-month CD outweighs the multi-year stability of a 2-year or 3-year CD.
- Track Grace Periods: If you hold maturing CDs, use our CD Maturity Date Tracker so you don’t miss your 10-day renewal window.