bank rates

When The Fed Boosts Rates, Then What?

percent signSix years after the Federal Reserve put a choke hold on interest rates, you can be forgiven if you can’t remember a time when the nation’s central bank actually raised rates.

With the Fed perhaps, maybe, hopefully looking to loosen its grip a bit in 2015, we thought it might be interesting to look back at the last time rates were on the rise to see if there’s anything to be learned.

From June 2004 through June 2006, the Federal Reserve’s rate-setting committee boosted short-term interest rates 17 times, from 1.00% to 5.25%.

This short-term rate, called the federal funds rate, is the bank-to-bank lending charge the central bank sets. It influences all sorts of other yields, including those on savings accounts and certificates of deposit.

So what happened to CD rates during that federal funds rate run-up?

The chart below shows the average 5-year CD trended upward over that time period but at a much, much more gradual incline.

The average 60-month CD paid 3.6% APY when the central bank first increased the federal funds rate in June 2004. Following the final rate increase in June 2006, the average 5-year CD peaked at 4.3% APY.

It’s clear there wasn’t a direct correlation back then. So we shouldn’t expect a sudden quarter-point boost in CD rate offerings when the federal funds rate begins to rise this time around.

In fact, the average 60-month CD rate historically has been more closely in line with the 5-year treasury yield, although the spread between the two has been fairly large during the last two years.

So, while we can’t say for certain what the path forward will be, we can make an educated guess that savers won’t be able to earn a decent return until the Fed significantly boosts the federal funds rate and the yield on 5-year treasuries returns to something resembling historical norms.

And that’s not likely to happen for years.

The Los Angeles Times added another pessimistic voice this week in a story that attempted to forecast what might happen next.

The upshot:

“Yet many economists and investment pros believe that neither short-term nor long-term rates will go significantly higher, and stay there, in the next few years. More likely, they say, are modest increases that might even be quickly reversed.”

In other words, it’s going to take a long, long time to climb up from the bottom.

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