CD Rates Before The FOMC Meeting, The Calm Before the Storm
All eyes are on the Federal Open Market Committee (FOMC) this week as they wrap up their two day meeting today. Shortly after their meeting, the FOMC will release a statement on economic policy. Over the past several years there hasn't been much of a policy change meeting to meeting but this time is different.
There are a few policy changes the FOMC can make as the economy improves and the unemployment rate falls. The first and biggest policy tool the FOMC has is the option to change the federal funds rate - the rate at which banks pay to borrow money overnight. The second policy tool the FOMC can employ is tapering their purchases of mortgage-backed securities (MBS) and long term U.S. Treasuries.
FOMC has Driven Mortgage Rates and CD Rates to Record Lows
The FOMC has been buying $40 billion a month in MBS and $45 billion a month in long term U.S. Treasuries to drive long term interest rates down. These policy tools have been every effective and drove mortgage rates and long term bond yields to record lows over the past several years. The downside to this is that CD rates, savings rates, and all deposit rates have also been driven down to record lows.
Fixed conforming 30 year mortgage rates hit a record low of 3.27 percent earlier in 2013, the lowest point ever recorded by Freddie Mac. Average 1 year bank CD rates in the Federal Deposit Insurance Corporation's (FDIC) weekly rate survey hit a low of 0.20 percent two days ago.
What will the FOMC Statement Say?
Over the past several months, long term bond yields and mortgage rates moved over 100 basis points higher on the possibility of the Fed slowing their purchases of MBS and long term bonds. Rates moved higher despite the Fed still buying a combined $85 billion a month in both bonds and MBS.
The Fed is very aware of market forces driving these rates higher so they won't change policy too much which would scare the markets into sending rates even higher. The Fed won't increase the fed funds rate from the current level of zero percent to ¼ percent. In fact, the Fed has uncharacteristically stated they plan to keep this rate at near zero percent until the nation's unemployment rate falls below 6.5 percent.
What the Fed will change during this meeting is in all likelihood announcing a tapering of their purchases but I believe they will slowly wind down their purchases. They will probably make monthly incremental steps, probably $5 billion a month less in purchases, nothing too drastic that would sent rates higher quickly.
How the Markets Will React
The reaction from the markets will be muted. 10 year bond rates have already soared from around 1.60 percent in mid May to just under 3.00 percent in late August. 1o year rates will be range bound from 2.60 percent to 3.00 percent for the rest of 2013. This will keep a lid on 30 year conforming mortgage rates from rising above 5.00 percent.
The response from equities will also be muted but longer term as the liquidity from the Fed dries up, the markets will underperform their gains since the financial crisis.
Will Bank Increase CD Rates if the Fed Changes Policy?
This time around the answer is no, even if the Fed slows their purchases. CD rates at banks and credit unions won't move higher until the Fed increases the fed funds rate, which won't happen until the unemployment rate falls below 6.5 percent. The current unemployment rate is at 7.4 percent and will probably fall to 6.5 percent sometime in the first half of 2014.
The Fed will increase the fed funds rate sometime in the summer of 2014. At that point, banks will follow suit by increasing CD interest rates. The increase in the fed funds rate will probably come in 50 basis point (0.50%) increments. The increase in CD rates will come soon after and probably will also be in 50 point increments.
Which CD Terms are Best Until CD Rates Move Higher?
Since rates on certificates of deposit will finally be moving higher after over 5 years of declining, don't lock into a long term CD right now. Banks know rates are moving higher and have increased long term CD rates, 5 years or more, to entice people to look into a long term CD.
The best CD rates on 5 year certificates of deposit moved about 33 percent higher the past month. The best rates used to be around 1.50 percent but now you can find banks offering rates just above 2.00 percent. While a 33 percent move higher in 5 year rates is a big jump, locking in a 5 year CD rate at 2.00 right now wouldn't be a good move.
By the end of 2014, 1 year CD rates will be around 2.00 percent if the economy continues to grow at the current pace. If the economy picks up steam and the inflation rate moves above the Fed's long term targeted range of 2.00 percent, rates will move much higher quickly. If this scenario plays out, 1 year CD rates will move to around 4.00 percent to 5.00 percent.
Long term rates will also move higher but don't lock into a 5 year CD until we have reached the peak of Fed tightening. At this point we can't predict when this will happen but hopefully it won't happen for at least three more years.
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