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CD Rates Remain Low as New Fed Chairman Yellen to Continue Low Rate Policy

CD rates remain low as the Federal Open Market Committee will leave their policy on the federal funds rate intact when they meet next week, despite a surprising drop in the unemployment rate. The unemployment rate fell last month from 7.0 percent to 6.7 percent but a drop below 6.5 percent is no longer a trigger to increase in the federal funds rate.

Prior to last month's meeting, many believed the Fed would increase the federal funds rate when the unemployment rate fell below 6.5 percent. We, too, believed this was going to happen sometime in 2014 which would send CD rates and other deposit rates higher.

Just after the December meeting, the FOMC released a statement squashing a higher fed funds rate:
The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal.

Low Fed Funds Rate Will Keep a Lid on CD Rates

The current Federal Reserve Chairman, Ben Bernanke, will hand the reigns to Janet Yellen next month, who will continue with the policy of keeping the federal funds rate near zero percent. This will keep bank CD rates, savings rates, and money market rates low as well for the foreseeable future. Deposit rates are not expected to move higher until sometime in the middle of 2015.

The Fed is expected to continue to lower their monthly purchases of U.S. Treasuries and mortgage-backed securities. Last month the Fed announced they would buy $10 billion a month less in these securities each month until they stop all buys by the end of 2014. The bond market took this news pretty well and didn't sell off.

The anticipation of the Fed reducing their buys sent long-term bond yields higher but since the news was announced, rates on 10 year bonds have declined about 0.15 percent. Lower bond rates have contributed to mortgage rates moving lower this week as 30 year rates fell back below 4.50 percent this week.

Some Financial Institutions Will Increase CD Rates in 2014

A majority of banks and credit unions won't increase their CD rates until 2015 but there will be a few financial institutions increasing their rates in 2014. We have already seen a few banks increase their long term CD rates in response to higher long term bond rates. Late in the fall of 2013, the highest CD rates on 5 year certificates of deposit were around 1.50 percent. Now there are several banks offering 5 year rates around 2.00 percent.

One credit union, Pentagon Federal Credit Union (PenFed), increased all of their "money market" CD rates and are now offering some of the best rates. PenFed's 3 year CD rates are just above 2.00 percent and their 4 year rates are at 2.20 percent. Average rates on these CD terms are much lower. Average 3 year rates in the FDIC survey this week are at 0.45 percent and average 4 year rates are at 0.57 percent.

The biggest increase in PenFed's rates were in their 5 year money market CD rates. The credit union's 5 year rates are at 3.00 percent with an APY of 3.04 percent, far above the 2 percent range that a few banks are offering. PenFed's 5 year rate is more than 4 times the FDIC's current average 5 year rate of 0.75 percent.

Invest in Shorter Term Certificates of Deposit

Heading into this 6th year cycle of low interest rates, you might be tempted to lock into a 5 year certificate of deposit at 2 to 3 percent but it would be unwise to do so. Make no mistake about it, interest rates are headed higher sometime this year or next so it doesn't make sense to lock into a low rate for a longer term.

The economy is finally growing robustly, due in part to the Fed's policies of keeping the fed funds rate near zero percent and doing three different rounds of quantitative easing (QE). When growth is strong, the Fed likes to take a more neutral stance that neither fosters nor inhibits growth.

The Fed has already started winding down their most recent round of easing (QE3) by buying $10 billion a month less in securities. The next policy change will be to increase the federal funds rate, which will probably happen sometime in 2015 as a majority of Fed Committee Members believe they will vote for a higher rate next year.

Higher CD rates in 2014 or 2015

There is also a change the fed funds rate will be increased sometime in 2014 but that would be dependent on a higher outlook for inflation. The current inflation rate is at 1.1 percent, well below the point at which the fed would increase the fed funds rate. 2014 or 2015, either way don't put yourself in a position on missing out on higher rates, stay invested in shorter term certificates of deposit.

A neutral fed funds rate, that doesn't foster or constrict growth would be a rate of around 2 percent to 3 percent. A fed funds rate of 3.00 percent would send 1 year bank CD rates upward of 3.00 percent, which would be welcome news. Stronger growth or the threat of inflation in 2014 or 2015 would send 1 year rates even higher, so don't lock into a long term CD account now.
Author: Brian McKay
January 22nd, 2014