- Since early 2022, the Federal Reserve has aggressively hiked the federal funds rate eight times, putting upward pressure on interest rates for loans and investment vehicles of all types, including CDs.
- The Fed’s tightening action has slowed, but inflationary pressure persists. As a result, we are likely to see another modest rate hike or two in 2023.
- This should not discourage CD investors from putting new money to work, but maintaining an awareness of the economy and the trajectory of interest rates is important.
- Before investing in a CD, be sure to shop around to pinpoint the highest yielding CDs on the market.
What Determines When CD Rates Go Up?
The primary driver of certificate of deposit (CD) rates is the federal funds rate, the overnight lending rate for depository institutions and the foundation for all longer-term lending arrangements. The U.S. Federal Reserve uses this rate to influence domestic monetary conditions and achieve its dual mandate of maintaining price stability and maximizing employment.
During periods of high inflation and low unemployment, the Fed generally cools the economy by bumping the federal funds rate to temper demand and slow the rate at which money changes hands. During periods of low inflation and high unemployment, the Fed usually cuts the rate to stimulate demand and boost the economy.
Since mid-2021, the U.S. has experienced heightened levels of inflation. Throughout 2022, the price pressure was extreme and resulted in the highest Consumer Price Index (CPI) readings observed in over 40 years. Inflation peaked at 9.10% in June 2022. It has declined some since but remains north of 6.00%.
The Fed has been working aggressively to counteract the surge. As illustrated below, it has hiked the federal funds rate eight times since the beginning of 2022. This took it from a target range of 0.00%–0.25% to 4.50%-4.75%, the highest level since 2007.
The recent trajectory of CD rates has been positively correlated with these federal funds rate hikes.
CDs are a stable investment that offer benefits to a balanced portfolio. Contact a qualified investment advisor to see if a CD will help to achieve your investment goals.
How Have CD Rates Risen in the Past?
CDs have many maturity terms, most of which range from 30 days to five years. For the sake of simplicity, let’s focus on the one-year and five-year terms. Based on data compiled by the Federal Deposit Insurance Corporation (FDIC), the national average rate for CDs with these terms has changed as follows over the past year:
The change in the federal funds rate correlates with the approximately 1.00% increase for both CD tenures. However, average CD rates have moved at a much more measured pace, resulting in a current yield of about 1.25% for both the one-year and five-year instruments.
This is incredibly underwhelming for investors. However, it is important to remember that we are looking at national averages. Top-tier rates are typically five to six times higher than the national average.
Today, the most competitive rates for the one-year and five-year tenures fall between 4.50% and 5.00%, which approximates the current federal funds rate.
When Will CD Rates Go Up?
The Fed began reducing the size of its federal funds rate hikes in late 2022, but it continues to employ a restrictive monetary stance. It raised the federal funds rate by 0.25% in February 2023 and is widely expected to implement another 0.25% bump by mid-year.
If the economy remains relatively robust, we may see two 0.25% rate hikes before the end of the year, which would put the target range for the federal funds rate at 5.00%-5.25%. Beyond that, any signs of softening economic conditions are likely to result in rate cuts.
Gauging exactly when the Fed will move and how closely CD rates will align is difficult to do. Nevertheless, based on recent developments, it is plausible to expect rates to be modestly higher in June 2023 than they are today, and higher still in September 2023.
Implications for Investors
High inflation and rising rates are a real burden for most people, especially borrowers. That said, higher rates are a good thing for fixed-income investors, particularly those looking to put new money to work. The primary benefit is clear — greater interest income.
However, there is some risk. If you invest in a fixed-rate CD or bond and rates continue to rise, the economic value of your investment will decrease because it offers a lower rate than achievable in the market.
This risk is greatest in rapidly rising interest rate environments like those experienced in 2022. While we are likely to see another modest rate hike or two in 2023, we should see nothing close to what transpired last year.
It is important to maintain an awareness of the economy and the trajectory of interest rates. Moreover, when contemplating a CD investment, it is critical to shop around and pinpoint the highest-yielding vehicles in the market.
Finally, before investing in a CD, make sure you are comfortable locking up your cash for the specified term.
Other Frequently Asked Questions About CD Rates
CD rates vary depending on the interest rate environment in which they are issued. As the federal funds rate rises, CD rates usually rise. Conversely, as it declines, CD rates usually decline. Longer CD terms usually garner higher interest compensation than shorter terms, holding all else constant.
During recessionary environments, the Federal Reserve usually cuts the federal funds rate to stimulate borrowing activity and prop up the economy. Generally, this results in lower CD rates. Many people believe we are currently experiencing a recession, but we have not seen firm evidence of this and rates are on the rise.
You can search for the best CD rates online. Visit Annuity.org for the best CD rates currently available.