bank rates

Higher Rates Are Coming…Here’s What You Need to Know About The Fed’s Plan

If you’re socking money away – especially if you’re buying CDs and must decide how long to tie up your funds – what’s happening with the Federal Reserve is worth following.

Big changes are afoot, and the savvy saver will be equipped to make the most of them.

Higher interest rates may not come as soon as we like (it’s far too late for that), nor will rates increase as quickly as we’d like. But at least we know they’ll be taking us in a welcome, upward direction.

The Fed’s rate-setting committee meets next week to pore over reams of economic data and debate the burning question of when to finally start “normalizing” interest rates.

As our country’s bank-for-banks, the Fed wields the tremendous power to determine how much you and I can earn on our savings.

For more than six years now, it’s kept returns anchored at historic lows as a stimulus to lift the economy out of the Great Recession.

It did this by reducing the federal funds rate – the interest that banks pay to borrow money through the Fed – all the way down to essentially zero in December 2008 and has kept it tethered there ever since.

That’s allowed banks to get almost all of the money they need for loans free through the Fed and therefore slash what they’re willing to pay savers for deposits.

With the economy now improving, the Fed’s rate-setting committee is preparing to return the federal funds rate to a more normal level, which will be a tremendous boon for savers because banks will need our money again.

But exactly when the Fed will start raising rates is impossible to know.

What we do know with reasonable certainty is that we won’t see a rate hike at next week’s meeting.

At this point, the earliest the Fed would raise rates is its June 16-17 meeting, with a majority of economists and Wall Street traders believing September or even December are more likely.

Why the hesitation? Isn’t the Great Recession long over by now?

While that bleak period is indeed officially behind us, the economy suffered significant structural damage from the financial crisis, and it’s taking longer than any of us hoped to get all of the pistons firing at full capacity again.

In the Fed’s analysis of a staggering number of indicators, two economic measures carry outsized weight in their decision-making: the inflation rate, and jobs and wage growth.

The Fed considers 2% inflation to be the sweet spot reflecting an economy growing neither too fast nor too slow, and as such, it has become the Fed’s target on where it wants to see inflation before it starts raising rates.

Unfortunately, the Fed has been left waiting (and us with them) for quite some time, as core inflation – which excludes volatile food and energy prices – has lingered below the Fed’s 2% target for almost three years now.

With the March inflation data, however, came a glimmer of mildly good news: Core inflation was up for the third month in a row and climbed 1.8% over the previous year, making it the biggest 12-month advance since October.

As for jobs and wage growth, the current data are a bit murky. After several months of better-than-expected jobs reports, the most recent figure showed the smallest gain in 15 months. Yet average hourly earnings were more encouraging than in the past.

These and other indicators of a “soft” first quarter have put the Fed in “wait-and-see” mode: Was the lack of strong growth a transitory phenomenon triggered by a harsh Northeast winter, bottlenecks at West Coast ports and fluctuating oil prices? Or will this be a second quarter trend as well?

Cleveland Fed President Loretta Mester said that while she expects this weakness to be transitory, she’s looking for the evidence.

“I want to see whether the data is going to be consistent with my forecast,” she said recently in a Bloomberg interview. “We’re going to get a lot of data between now and June.”

Because the Fed can’t entirely predict how the economy will react to the first rate hike in 10 years, many committee members are also envisioning a slower ramp-up of rates than was previously anticipated, with perhaps just one or two rate hikes in 2015 instead of the earlier expectation of three.

Indeed, officials in March predicted the funds rate would reach 1.875 percent by the end of 2016 and 3.125 percent the following year.

But investor expectations are significantly lower, predicting rates will have barely moved above 1 percent in 2016 and will still be under 2 percent when 2017 ends.

Wall Street’s odds on when the Fed will raise rates is a probability measured by the CME Group FedWatch. Currently, it calculates the probability of the first rate increase occurring in June to be 2%; in July, 11%; in September, 28%; and in October, 46%.

It isn’t until December that FedWatch’s odds are better than even, at 59%.

Bloomberg’s monthly survey of top economists found that 71% are now forecasting a September rate hike. Just last month a majority were predicting a June increase.

The Fed will release its post-meeting statement Wednesday afternoon, at which time we’ll report on any new clues it delivers.

Don't miss out on the next bank deal. Get the newest deals delivered straight to your inbox!

Comments (1)
1 Star2 Stars3 Stars4 Stars5 Stars (9 votes, average: 3.78 out of 5)
One Existing Comment
  1. James K said:
    on April 25th at 09:25 am

    Right!? That is why the “I” part of the ibonds would have a negative rate effective May 1st but for the requirement that the overall rate not be below zero. More months will need to pass…