Federal Reserve Concerned About Stimulus Side Effects Which Could Lead to Higher CD Rates Before Mid-2015

Even though the Fed has decided to maintain aggressive stimulus measures in December's Fed meeting to support the recovery and bring down high unemployment, policymakers were divided on when to end these aggressive measures. If the Fed changes their accommodating stance to stimulate the economy we will see higher CD rates and higher rates on all interest bearing assets sooner than mid-2015, the current time frame the Fed is expected to keep rates low.

The rift between Federal Reserve policymakers might end the purchases of bonds and mortgage backed securities sooner than expected if more Fed voting members decide there is too much stimulus in the system. In the meeting minutes the Fed also said they planned to maintain interest rates at near zero percent until 2015 but I believe that will probably change before then as well. Once the Fed increases the Fed funds rate and discount rate banks will follow suit increasing interest rates on deposit accounts.

Higher interest rates will be welcome news to holders of these interest bearing assets. We have suffered with low rates for many years now. Right now the best CD rates available on all certificate of deposit terms are very low regardless of how long the certificate of deposit term is. The CD rate spread between the shortest term certificates of deposit and the longest term certificates of deposit is less than 0.75 percent.

The highest CD rates on 1 year certificates of deposit are at 1.04 percent and the highest CD rates at banks on 5 year certificates of deposit are at 1.78 percent, a 0.74 percent difference. Nobody really knows exactly when interest rates will move higher but the Fed will be the final decision maker on when rates move up.

We at least know rates will move higher by mid-2015 but if the unemployment rate falls below 6.50 percent or if the inflation rate moves above 2.50 percent the Fed will increase rates before then. I personally believe rates will move higher in late 2013 or in the first half of 2014 especially if Washington can agree on budget cuts with minimal theatrics and damage to the economy.

The interest in rates will be swift since rates are so low right now. If the Fed increases the Fed funds rate from the current targeted range of zero percent to one quarter percent to a neutral stance it will require them to increase the rate at least 200 basis points. Banks will follow suit by increasing CD bank rates, savings rates and money market rates by at least 100 basis points to around 2.00 percent from current levels.

Author: Stacy Everest
January 6th, 2013