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Fed Comments Scare Markets, Are Higher CD Rates on the Way Sooner Than Thought?

Fed Comments Scare Markets, Are Higher CD Rates on the Way Sooner Than Thought?

Gold, Oil, Copper, equity markets, and bond yields all declined yesterday on the Fed's comments that they might slow or stop their stimulus programs sooner than thought. A minority of fed officials, who are becoming more vocal, are making their case that the fed should slow or stop their buying of $85 billion a month in bonds and mortgage-backed securities (MBS).

Fed Comments Scare Markets, Are Higher CD Rates on the Way Sooner Than ThoughtTheir belief is the current policies of keeping interest rates artificially low encourage more risk and are creating new asset bubbles which will eventually burst. The Fed Chairman, Ben Bernanke, and the majority of fed officials will keep the more accommodative stance on monetary policy to spur growth and lower the unemployment rate.

In Fed's January minutes, the fed said they will stay the course on its stimulus policies to lower the unemployment rate. At this point, the plan is to continue buying $85 billion a month in securities and keep the fed funds rate near zero percent. They will continue these policies until the unemployment rate falls below 6.5 percent, which the fed believes will happen towards the end of 2015.

10 year U.S. Treasury yields are down 5 basis points and are back below 2.00 percent this morning. Yields are down as investors flee to the safety of Treasuries, sending bond prices higher and yields lower. If the minority of fed officials are right, the decline in bond yields is temporary and will move higher before the end of 2013 as the markets reassess interest rates and inflation.

Inflation higher than the fed's comfort zone of 2.00 percent to 2.50 percent will force the fed's hand to increase the fed rates prior to the unemployment rate falling below 6.50 percent. A higher fed funds rate will drive CD rates and other deposit account rates higher. Higher CD rates will be welcome news for depositors since the best CD rates on 1 year certificates of deposit are around 1.00 percent.

Three factors playing out in Washington D.C. will also have an intermediate effect on interest rates. The sequestration of government spending cuts, to start taking affect March 1, 2013, the fiscal budget for 2013 and the debt ceiling limit. Depending on how these issues are resolved will also determine the direction of interest rates this year.

If deals are made in time without too much spending reduction, the economy will take off, sending interest rates higher. If deals aren't made and the economy falls into another recession interest rates will make new lows.

Author: James Martin
February 21st, 2013