Following the recent global pandemic, the Federal Reserve has been systematically raising the Fed fund rates to withstand inflation and stabilize overall economic growth. The markedly high rates have been noticeable since March 2022, when the rates grew to 4.75%. As of July 27, 2023, the average Fed rate has recorded 5.25%-5.50% APY.
Economists expect that these rates will continue to fluctuate in the upward direction for some more time. This is because the Federal Reserve keeps trying to manage the economic condition in the current high-inflation environment. However, as the changes in Fed Rates affect other financial instruments like Certificates of Deposits (CDs), the concern about its impact on CD rates is also worth noting. For the sake of argument, it is best to consider both sides of this situation.
With the higher Fed rates, we also see a consequent incline of CD rates, with some options reaching over 5.00% APY. For people planning to save their money, this increase is good for getting high returns in the future. However, these Fed rate fluctuations are not the best for people borrowing capital from banks. So, one must consider their main aim with their finances first, like whether to save or increase their funds. Then, they can favorably choose to invest in CDs at this time.
What is the leading way Fed rate fluctuations affect CD rates?
The Federal Reserve has autonomy over how much of the surplus balance available in their reserve account they lend to banks. They charge Federal fund rates (commonly called Fed rates) for this. This is the interest rate at which these banks, credit unions, or financial institutions borrow funds from the surplus balance available in the Federal Reserve overnight.
If the Federal Reserve charges a high Fed rate, the banks can, in turn, increase the interest rate they offer their customers for their deposits. This is what happens in the case of CD rates since CDs are a type of savings product that banks or credit unions give customers. The money the customers put into their CD accrues interest consistently over the entire fixed term of the deposits. With a rise in the Federal fund rate, the banks increase the interest rate on the deposit accounts like the CDs they handle. This way, they can get more deposits and avoid losses.
Do CD rates entirely depend on the Federal Reserve?
The Federal Reserve indeed increases the Fed rates often, as seen with the fluctuations of APY between 1.00% in June 2003 to 5.25% in July 2023. With the changes in Fed rates, the CD rates also see consequent fluctuations, although not precisely the same each time. Consequently, many banks and credit unions have increased the rates for their high-yield savings accounts and CDs, up to as high as 5.26% APY.
However, the federal funds rate is only one of the factors affecting CD rates. Here are some of the other factors to keep in mind:
- Different banks offer competitive rates to attract more depositors.
- Banks charge higher APY on CDs with smaller term lengths, like six-month CDs, than CDs with longer term lengths.
- Increasing Treasury yields, i.e., the interest rate for the U.S. government to pay on external debt, can cause a rise in CD yields.
Will the Fed Rates Increase Again?
The Federal Open Market Committee, or FOMC, sets the Fed rates. Many factors influence this, like the unemployment rates in the country, inflation, and the current economic condition. Market changes, consumer behavior fluctuations, technological advancements, etc, further impact such factors.
Individually, each of these conditions is unpredictable. So, even if economists can perfectly study the market factors to predict inflation and economic growth, it will be inaccurate. Therefore, it is impossible to guarantee how the Fed rates will fluctuate in the future, although economists can make educated guesses.
The Chairman of the Federal Reserve, Jerome Powell, said in a recent press conference that the team would first depend on researching current economic data. Then, at each meeting, they will discuss their findings and decide how to adjust Fed rates.
The verdict- should you invest in CD rates at this time?
Banks and other financial institutions charge specific interest rates on the deposit balance of their customers with their selected financial products. Common examples of these products include savings accounts and certificate of deposit accounts. However, the former is more geared toward long-term savings, while the latter is better for short-term savings.
Many of the banks and credit unions are already increasing their deposit rates in expectation of future increases in Fed rates in the same way. So, it is suitable for people to add their medium-term savings into a new CD to lock it in while the interest rates are high. Most CDs involve a fixed interest rate and APY for their overall term. So, if a person opens a CD with a high-interest rate, the interest accrued at maturity will also increase. This is why CDs are considered the safest investment option as long as it fully matures over the set time.
Yet, it is better to err on the side of caution. Banks and credit unions are bumping their average rates for CDs in anticipation of high Fed rates in the upcoming months. While CDs are safe to invest in for people interested in saving their money, the amount they can save is minimal. Moreover, it is impossible to depend on CDs to fight inflation, and predicting that Fed rates will increase again is not guaranteed. So, better courses of action exist than waiting for higher CD rates.
People can leave their savings in the CD for a fixed term, whether six months or five years and get relatively good compound interest. Currently, there are record-high APY for CDs that banks are offering. For example, a CD with a 3-month term will come with a 5.20% APY while a CD with a term of five years can get 4.77% APY, as per the national average. So, opening a CD now is a profitable choice for getting a suitably high interest on the saved amount at maturity. Of course, it is vital to first research the competitive rates of CDs thoroughly, alongside reading through additional terms and conditions.
Author Bio:
Lyle Solomon has extensive legal experience as well as in-depth knowledge and experience in consumer finance and writing. He has been a member of the California State Bar since 2003. He graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, in 1998, and currently works for the Oak View Law Group in California as a principal attorney.
