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Stronger Economic Growth Means Interest Rates Set to Increase Sooner

For several years now, we have all been waiting for higher deposit rates on savings accounts, money market accounts, and certificates of deposit. Two stronger-than-expected economic reports released this morning point to the possibility of higher interest rates sooner than later.

The big news was that 3rd quarter GDP growth came in at a robust 3.6 percent, much higher than the 2.8 percent that analysts were expecting. The second strong report was weekly jobless claims, which the Labor Department reported came in at 298,000, much lower than the expected number of 325,000. This is the lowest number of claims since December 2007.



Higher Bond Rates Forcing Mortgage Rates Higher


10 year bond yields are soaring up to 2.86 percent on the news, nearing the highest point for rates in 2013. Clearly the economy is finally recovering and growing more quickly, which will force the Federal Reserve to start tapering their purchases of long term bonds and mortgage-backed securities.

The possibility of this third round of quantitative easing (QE3) ending is the driving factor sending interest rates on bond yields and mortgage rates higher right now. Stronger growth and lower unemployment will cause inflation to move higher, which will also force the Federal Reserve to increase the federal funds rate.

Savings and CD Rates Dependent on a Higher Federal Funds Rate


When the fed funds rate is increased from the current range of zero to one quarter percent, savings rates, money market rates, and CD interest rates will move higher.  We have been dealing with ultra low deposit rates for over 5 years now and any uptick in rates will be welcome news for depositors.

When exactly the Fed starts easing doesn't matter as far as mortgage rates are concerned. Rates will be moving higher from current levels. When deposit rates increase is still tied to when the federal funds rate is increased and that isn't expected to happen until the unemployment rate falls between 6.5 percent and 5.5 percent or when the expectation that the future inflation rate will move above the Fed's long-term target of 2 percent.

When Will The Fed End QE3 and Increase the Fed Funds Rate?


Instead of trying to figure out when the Fed will start the process of ending QE3, I believe by the late spring of 2014 QE3 will be history. As for when the fed funds rate will be increased, the Fed has stated they will increase the rate when the unemployment rate falls below 6.5 percent. The current rate is at 7.3 percent, so we may be only 0.8 percent away from a higher fed funds rate.

However, a higher fed funds rate when unemployment falls below 6.5 percent was the Fed's mantra until the last Federal Open Market Committee (FOMC) meeting. Now we are hearing they might keep the rate at current levels until the unemployment rate falls below 5.5 percent.

With today's news on growth and jobless claims, the Fed might be more inclined to increase the rate when unemployment falls below 6.5 percent. I believe this is more likely because really strong economic data will give the Fed a clearer picture on future growth and raise concerns regarding inflation.

Deposit Rates Will Move Higher in the Summer of 2014


Based on today's news, I'm holding firm to the belief that deposit rates will move higher sometime after the Fed's June 2014 meeting. You should stay invested either in variable rate accounts such as savings account and money market accounts or invested in short term certificates of deposit of 6 months or less.

By the summer of 2014, the best savings rates and money market rates will move towards 2 percent. The best CD rates on 1 year certificates of deposit will also be near 2 percent and possibly higher than that since banks will be keen on locking in deposits before rates move much higher.
 
Author: Brian McKay
December 6th, 2013