bank rates

Will The Fed Take The First Step Toward Higher Interest Rates This Week?

It’s a little early to pull out the party horns, but there could be some good news on the distant horizon for your personal savings.

The Federal Reserve, the nation’s central bank, may be about to start bowing out of its effort to prop up the economy by driving down interest rates.

If that happens, interest rates on CDs, money markets and even savings accounts should eventually start paying a higher rate of return.

However, these important consumer savings options won’t quickly return to the interest rates paid before the financial crisis that started in 2008.

A return to the reasonable rates of return that were normal before the crisis could still be more than a year away.

Still, the Fed’s move would be the first step toward returning to the days when you could make more than the ridiculous 0.23% APY that’s currently the national average for one-year CDs.

In 2007, in comparison, they were above 3.6%.

Chart showing the average 1 year CD rate from 2007-2013.
Since the economy went off the rails, the Fed has taken several steps to keep the cost of borrowing money as low as possible. The idea is to encourage business and consumer spending, spurring growth.

One way the Fed has been doing this is by purchasing trillions of dollars in Treasury Securities and mortgage-backed bonds, which has the effect of flooding the markets with money, pushing down long-term interest rates for mortgages and everything else.

But last spring, Fed Chairman Ben Bernanke indicated the Fed believes the economic recovery is far enough along that it should be able to gradually reduce those purchases this year.

The formal announcement of such a move is expected at the next meeting of the Fed’s rate setting committee on Tuesday and Wednesday.

Unemployment fell to 7.3% in August, according to the government’s jobs report. Bernanke said the Fed expects it will fall to 7% next summer.

When unemployment reaches that level, the Fed is likely to end its debt-purchasing program altogether, he indicated.

When the jobless rate reaches 6.5%, Bernanke said the Fed would turn to raising short-term interest rates — the ones that affect things like CDs and money market and savings accounts.

When that might be is uncertain, but if the recovery says on track, it could be about a year and a half.

Chart showing the the unemployment rate from 2007 to 2013

The main way the Fed influences how much we make on short-term savings is through the “federal funds rate,” which is the interest rate it charges banks to borrow money other banks have deposited with the Fed.

That rate essentially has been zero since December 2008, which means commercial banks can get pretty much all of the money they need from the Fed — for free. They don’t need our deposits, which is why they’re paying so little for our savings.

Bernanke expects it could take the Fed several more years to gradually boost short-term savings rates to normal levels. However, some analysts believe rates could climb more quickly once the Fed begins shifting policy.

Even this possibility of distant good news, however, comes with qualifications.

First, it’s not certain what the Fed will do. Fed Chairman Ben Bernanke has signaled pretty strongly that this is the direction it is leaning. But there is resistance within the overall Fed leadership.

Federal Reserve Bank of St. Louis President James Bullard has been the most outspoken about his belief the economy should strengthen more and unemployment fall more significantly before the Fed changes direction.

Second, two different government spending fights loom on Capitol Hill that could derail the economic recovery, which could cause the Fed to hesitate or even reverse itself.

The most immediate of those two comes on Sept. 30, just 12 days after the Fed meeting, when the government will run out of authority to spend money unless it passes something called a “continuing resolution” that allows it to keep functioning.

Without a resolution, the possibility of a government shutdown looms. If you feel like you’ve heard this before, you have. It’s become a regular ritual since Republicans retook the House, creating a divided government.

But each time it risks setting back the economy. This time, the Tea Party wing of the Republican Party wants to use the threat of a shutdown to “defund” Obamacare, which essentially means killing the health care law by starving it of operating money.

There is exactly zero chance the president or Senate Democrats will let this happen. The question is how far the Republican Party feels it has to push to satisfy the Tea Party portion of its voting base.

Most political observers believe Republican leaders will hang on until the last minute to see if they can extract any concessions out of President Obama before giving in.

But a political miscalculation or a hardening of positions could, at least briefly, shutter the government, sending thousands of workers home, delaying some government checks and unsettling the overall economy.

If we skate by this cliff, another one looms almost immediately.

Sometime in mid-October, the U.S. government will reach its legal limit to borrow money. If the government doesn’t raise this “debt ceiling,” it risks defaulting on some of its debts.

This would be a very big deal, sending shock waves through financial markets worldwide and creating the kind of uncertainty that unnerves business and industry, causing them to hold back on hiring or significant spending until they get a clearer picture of what’s ahead.

It’s just what a still-shaky economic recovery doesn’t need.

Yet at this point Republican House Leader John Boehner says any increase in the debt ceiling must be accompanied by further cuts in federal spending. President Obama says raising the debt ceiling is a separate issue — a matter of honoring past obligations — and is refusing to negotiate.

Somebody is bluffing. Or we better hope so. If not, the Fed’s optimistic view that things are nudging back toward normal will go up in smoke.

You can bet the central bankers will be watching the latest Capitol Hill developments very closely as they meet.

What they decide will have implications that reach all the way down to our personal bank accounts.

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