Low Savings Rates Continue Into 2014 and Probably to 2015

Just when we thought we finally turned the corner and would see higher savings rates in 2014, that is unlikely now. If savings account rates, money market rates, and all deposit rates stay low in 2014, it would mark over 5 years of low rates.  Rates have been at historic lows ever since the Federal Reserve lowered their key benchmark interest rate, the federal funds rate, to near zero percent back in December 2008.

Savings Rates Were Set to Move Higher In the Summer of 2014

We all had hope that interest rates on deposit accounts would rise sometime in the second or third quarter of 2014 but the Federal Open Market Committee (FOMC) dashed our hopes. Since the fall of 2o12, the FOMC has said the following right after their meetings:

 Exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal.

Interest Rates Won't Move Higher with a 6.5 Percent Unemployment Rate

Inflation is still way below the long-run goal, so everyone took this as the fed funds rate would increase when the unemployment rate falls through 6.5 percent. In the FOMC Statement right after the December meeting, the FOMC backed away from what seemed to be a commitment to higher rates once the unemployment rate falls below 6.5 percent.
The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent.

The current unemployment rate in December was at 6.7 percent, only 0.2 percent from 6.5 percent. The rate fell 0.3 percent last month even though only 74,000 jobs were created because millions of people have stopped looking for work. Besides the millions who stopped looking for work, a 6.7 percent rate is good news but until inflation is higher, we won't see a higher fed funds rate even if the unemployment rate falls below 6.0 percent.

Higher Inflation is the Key to Higher CD Rates, Savings Rates, and Money Market Rates

CD rates, savings rates, and money market rates march in lockstep with the fed funds rate. When the rate goes higher, deposit rates move higher. When the fed funds rate decreases, deposit rates decrease. Now that inflation is the key indicator for higher interest rates, when will rates move higher?

The FOMC also releases forecasts for where they believe the inflation rate and fed funds rate will be in 2015, 2015, 2016, and 2017. The FOMC has 17 members, and only 2 of the 17 believe the fed funds rate will be increased in 2014. Whether or not this comes to pass remains to be seen but with a current inflation rate of 1.2 percent (CPI November 2012), higher rates in 2014 is now unlikely.

2015 is Now the Year for Higher Deposit Rates

The FOMC's Economic Projections for PCI inflation in the long run is expected to be at 2.00 percent, below the FOMC's long term target. Though inflation is still not expected to be a concern in the coming years, 12 of the 17 members believe 2015 will be the year for "policy firming," aka, a higher fed funds rate.

This means we will have to wait until 2015 for higher deposit rates. When exactly rates will move higher in 2015 is anyone's guess at this point. Of course we could see higher interest rates sooner than the projected 2015 timeline if economic growth picks up steam and inflation increases.

Once They Move Higher, Deposit Interest Rates Will Rise Quickly

The FOMC's policies of an exceptionally low fed funds rate combined with three different rounds of quantitative easing (QE3) in order to force interest rates lower are really helping the economy. Now that it finally looks like the economy is getting stronger, the FOMC is starting to pare back on the stimulus.

In the December meeting, the FOMC said they would lower their bond and mortgage-backed securities purchases from $85 billion a month to $75 billion a month. These purchases will cease by the end of 2014 and as a result, bond rates and mortgage rates are expected to continue moving higher this year.

The FOMC isn't expected to increase the fed funds rate until sometime in 2015 but when they do, the increases will be quick and sharp. To get to a neutral fed funds rate, where the rate isn't fostering or constricting growth, it needs to be above 2.00 percent and possibly as high as 3.00 percent, depending on growth and inflation.

When rates finally do rise they will rise quickly, which means we could see savings rates, money market rates, and 1 year CD rates around 3.00 percent. Currently, the best savings rates are at 1.00 percent, the best money market rates are at 0.90 percent, and the best 1 year CD rates are at 1.09 percent.

We recommend staying invested in shorter term certificates of deposit or variable interest rate accounts like savings accounts or money market accounts. In doing so, you can take advantage of higher rates when they finally do arrive.
Author: Brian McKay
January 15th, 2014