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Where are Savings Interest Rates Headed with the Fed Looking to Taper?

The all-important two day Federal Open Market Committee meeting started as the markets awaits news on whether or not the Fed will start tapering bond and mortgage-backed security (MBS) purchases. Bond rates have soared on the possibility that the Fed will scale back buying $40 billion a month in MBS and $45 billion a month in long term bonds.

The Fed's purchases have suppressed interest rates on bonds, all types of deposit accounts, and mortgage rates for many years now. As market forces drive interest rates higher, the Fed's policy becomes more and more obsolete. An improving economy and a lower unemployment rate are also forcing the Fed's hand at paring back their easing.

U.S. Consumer Confidence Higher This Week

The U.S. consumer is feeling more confident about the economy as well. The Gallup's U.S. Economic Confidence Index was-15 last week, up from -16 the previous week and up from -18 in the week ending Sept. 1. While consumers are feeling better about the economy for the past couple of weeks, the index is still down from June when the index stood at -3.

Interest Rates Already Higher on Possible FOMC Easing

The big question after the FOMC wraps up their meeting is how much higher interest rates will move if the Fed does announce they will be scaling back their purchases. The possibility of the Fed slowing their third round of quantitative easing (QE3) has sent long term interest rates higher the past several months while short term interest rates haven't budged at all.

Where are Savings Interest Rates Headed with the Fed Looking to TapperCurrent Savings Rates and Best Savings Rates Available

Current savings rates and money market account rates this week are averaging 0.63 percent for account balances of $50k or more. The best savings rates and money market rates in our rate database are higher than the average.

The best savings rate is at 1.00 percent and the best money market rate this week is at 0.90 percent.

Savings Rates and Money Market Rates Depend on a Higher Federal Funds Rate

Everyone has seen the headlines the past several months about mortgage rates and bond rates moving higher. If you searched for a rate on deposit accounts or short term certificates of deposit, you're probably surprised those rates haven't move higher. The reason being that rates on these accounts move higher once the federal funds rate is increased.

The Fed has kept the current federal funds rate near zero percent for almost 5 years now to help stimulate the economy. This policy has sent savings interest rates, money market rates, and CD rates down to record lows. During the FOMC meeting they will decide whether or not to increase the fed funds rate.

The possibility that the Fed will increase the federal funds rate is next to zero percent just because the Fed has already announced their intentions on the rate over a year ago. The Fed has stated multiple times the past year that they don't plan to increase the federal funds rate until the nation's unemployment rate drops below 6.5 percent.

The current unemployment rate is at 7.3 percent and probably won't fall to 6.5 percent until sometime early next year. So as far as when deposit rates will move higher, we will have to wait until at least late spring or early summer to see higher rates.

Default on U.S. Debt Would Sent Interest Rates Sharply Lower

There is another possible direction for interest rates if the Federal government defaults on its debt. If the politicians can't agree to raise the debt limit and technically defaults, bond rates would move sharply lower again. Interest rates would move sharply lower again because the markets would be spooked, selling stocks and commodities and buying U.S. Bonds.

A market move like this would be the initial reaction, called the classic "flight to quality." You're probably wondering why anyone would buy bonds of a country that just defaulted on its debt. Initially, that is how the markets would react. We saw this during the financial crisis just a few years ago.

The financial crisis started in the U.S. when the housing market collapsed and several Wall Street firms that dealt primarily in mortgage-backed securities failed.  Ultimately, everyone assumes the U.S. will pay its debt, which is why investors would still invest in U.S. Treasuries.
Author: Brian McKay
September 18th, 2013