Certificates of Deposit and Interest Rates
7.22.16 | CDs and Rates – Rusty Tweed team
1 Year CD
A one year CD gave you an interest rate of 1.53% 5 years ago. Current interest rates for a one year CD sit at 1.10%.
5 Year CD
A five year CD provided an interest rate of 2.63% 5 years ago. Current interest rates for a five year CD sit at 1.53%.
Why do CD Rates Change?
Interest rates can vary due to inflation, supply and demand and the federal funds rate. Rates rise when there is an increase in the demand for credit and fall when there is a decrease in demand. In a similar way, a rise in the supply of credit leads to reduced rates, while a drop increases them.
When inflation is higher, interest rates also rise. Lenders offer higher rates to make up for the falling purchasing power of the dollar.
The Federal Reserve Bank affects interest rates as well. Banks receive more money they can use for lending when the government purchases more U.S. securities, and accordingly lower interest rates. When the government sells securities, interest rates go up.
How the Fed Affects CD Rates
Last year, Ben Bernanke wrote that the rates set by the central bank follow the economy. This leads to low rates on certificates of deposit.
“While the Fed doesn’t set market interest rates such as Treasury bond rates and mortgage rates, it influences them through two key interest rates — the Fed discount rate and the federal funds rate,” says Robert Johnson, CFA, president of The American College of Financial Services in Bryn Mawr, Pennsylvania, and co-author of the book “Invest with the Fed.”
“Changes in the discount rate are considered a reliable signal of the Fed’s long-term policy intentions, or stance. Changes in the target fed funds rate are considered a shorter-term gauge of the stringency of Fed policy,” he says.
When the target federal funds rate increases, tighter monetary policy leads to higher rates for borrowing and economic growth is squeezed. As the fed funds rate goes up, so do CD rates.
“CD rates are highly correlated to Fed policy actions, following the fed funds rate extremely closely. Banks peg CD rates off of the federal funds rate,” Johnson says.
Watch the federal funds rate carefully to see if rates increase later this year. In the meantime, you may want to consider keeping your
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