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CD Rates Will Move Higher Next Year if Quantitative Easing Ends This Year

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There is even more hope that CD rates will move higher sometime in 2014. The Federal Reserve Chairman, Ben Bernanke, was guarded in his testimony on ending quantitative easing to the Joint Economic Committee of Congress. Ben said "if we see continued improvement and we have confidence that that is going to be sustained, then we could in -- in the next few meetings -- we could take a step down in our pace of purchases.”

The Federal Reserve has been buying $85 billion a month in mortgage backed securities and U.S. Treasuries to suppress long term interest rates. The Fed has been every effective at keeping rates low through their purchases and keeping the fed funds rate near zero percent. Their policies have driven bank CD rates down to record lows for both short term and long term rates.

CD Rates Will Move Higher Next Year if Quantitative Easing Ends This YearIf the economic landscape improves over the next few meetings, which by the way the next three Fed meetings take place over the next four months, the Fed could stop their purchases by the end of 2013. The last piece of the puzzle is the Fed increasing the fed funds rate. The Fed has stated that they plan to increase the rate when the unemployment rate falls below 6.5 percent.

The current unemployment rate is at 7.5 percent and has been falling on average 0.1 percent a month. If the rate continues to fall at this pace, we would see the unemployment rate at 6.8 percent in December 2013, just above 6.5 percent. The first Fed meeting in 2014 is set for January 28 and 29, the second meeting is set for March 18 and 19. By the March meeting the Fed might decide to increase the fed funds rate.

The increase in the rate will be rather quick because the current rate (at zero percent) is very accommodating. Just to get to a neutral level in the rate, the Fed will have to increase it by 100 to 150 basis points. That would force banks to increase deposit rates by almost as much on short term certificates of deposit.

Current 1 year CD rates at banks are only averaging 0.23 percent in the FDIC rate survey this week. The best CD rates on 1 year certificates of deposit are around 1.04 percent. If the scenario above plays out we could start seeing CD rates at banks move higher in the second quarter of 2014. By the end of 2014, 1 year rates could move as high as 2.00 percent, and savings rates and money market rates could follow suit.

A lot remains to come to pass for the Fed to stop their purchases and increase the fed funds rate. The markets already believe higher rates are on the way and they are driving long term Treasury yields higher. Since the beginning of May, 30 year Treasury yields have risen from 2.83 percent to 3.18 percent, an increase of 12 percent in less than three weeks.

Author: Brian McKay
May 28th, 2013