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Fed’s Yellen Sees Likely Increase in the Federal Funds Rate Later this Year

We heard it straight from the horse's mouth: higher interest rates this year. In a speech last Friday, Federal Reserve Chairwoman, Janet Yellen said, "I expect that conditions may warrant an increase in the federal funds rate target sometime this year." A higher fed funds rate in 2015 will also lead higher CD rates in 2015.

In Janet Yellen's speech, "Normalizing Monetary Policy: Prospects and Perspectives," she continued to prep the markets for a higher fed funds rate:

As you know, last week the Federal Open Market Committee (FOMC) changed its forward guidance pertaining to the federal funds rate. With continued improvement in economic conditions, an increase in the target range for that rate may well be warranted later this year.

What we don't know yet is exactly when the rate will be increased this year:
Of course, the timing of the first increase in the federal funds rate and its subsequent path will be determined by the Committee in light of incoming data on labor market conditions, inflation, and other aspects of the current expansion.

I still firmly believe an increase will happen in the FOMC's June meeting. The reason being that it can take up to six months for rate change (impact lag) to integrate into the economy. Another compelling reason is the fed funds rate being near zero percent is still very accommodating. The first rate hike will be a token increase of 0.25 percent, small enough not to shock the markets.

I also believe once the Fed starts the increase there will be subsequent 0.25 percent increases for the rest of their meetings throughout 2015 (Fed Meeting Calendar 2015). By the end of the year, the fed funds rate will be in a range of 1.00 percent to 1.25 percent.

CD Rates will Move Higher Once the Fed Funds Rate is Increased

Average CD Rates This WeekThe fed funds rate near 1.25 percent will cause 1 year CD rates to move above 2.00 percent. The best 1 year CD rates available will possibly be as high as 2.50 percent. Savings rates and money market rates will also move above 2.00 percent. If the fed funds rate remains near 0.75 percent to 1.00 percent, the highest 1 year CD rates will still be near 2.00 percent.

The best 1 year CD rates at banks available right now on the rate list are at 1.20 percent. The best 1 year rate from a credit union on the rate list is slightly higher at 1.30 percent. Average 1 year CD rates are slightly lower than both at 1.07 percent.

Mortgage Rates Will Also Move Higher on a Higher Fed Funds Rate

Higher deposit rates are welcome news for depositors but a higher fed funds rate will be a negative to homebuyers financing their purchase. Mortgage rates are not directly tied to the fed funds rate but tied to long term U.S. bond yields. An increase in the fed funds rate should send U.S. bond yields higher, which will cause mortgage rates to increase.

Bond yields should move higher because they have historically increased along with a higher fed funds rate. The increase might be muted this time because of the demand investors have for U.S. bonds. Investors have been pouring money into U.S. bonds because rates are much higher than Japanese and German bonds.

10 year U.S. Treasuries are currently yielding 1.94 percent, much higher than 10 year German bonds yielding 0.20 percent, and Japanese bonds yielding 0.36 percent.

Average mortgage rates this weekForecasts are for 30 year conforming mortgage rates to hit 5.00 percent by the end of 2015. 30 year mortgage rates today are averaging much less at 3.84 percent. I don't believe 30 year rates will hit 5.00 percent this year. A more likely scenario is for 30 year rates to top out around 4.50 percent.

30 year jumbo mortgage rates are currently averaging 4.10 percent. Forecasts for 30 year jumbo rates by the end of 2015 are also around 5.00 percent. By the end of the year, average 30 year jumbo rates will probably be around 4.75 percent.
Author: Brian McKay
March 30th, 2015