It only seems logical that certificate of deposit (CD) rates will go up at the same rate every time the Federal Reserve increases interest rates, but unfortunately, that’s not the way it works in the banking world. CDs make up a portion of the financial sector, and it’s important to stay on top of them when looking to invest. Let’s take a look at what kind of market conditions are needed for you to benefit from owning a CD and why CD rates may not go up as quickly as you would expect as interest rates rise.
Will CD Rates Continue to Rise?
While it’s not possible to predict exactly when CD rates will go up or down, it is helpful to understand how banks work and what causes the rates to go up when they do. Most investors watch the market, and, based on what they see, use the information to make investment decisions. Having the right information fuels better investment decisions, and that is true when trying to determine when CD rates will go up.
Over the past year, the Federal Reserve has been using interest rate hikes as a monetary tool to combat the inflation rate. Although rate increases took place for the better part of 2023, the general consensus now is that these rate hikes will slow to a pause during the summer of 2023. At the beginning of 2022, one-year CD rates were at a low of 0.13%, but by August, they had risen to an equally anemic 0.46%. That was bad news for investors or savers who were looking to grow their savings account, but since then, the rates have risen a little higher — Benzinga found one-year CD rates as high as 3.00%. But the rates are nowhere near what they’ve been in the past – one-year CD rates in the 1980s paid as much as 15%.
Although CD rates are tied to interest rates and they are going up, CD rates won’t rise as quickly as interest rates do. Let’s take a look at what some experts believe and what might happen going forward.
CD Rate Forecast
For the better part of 2022 and 2023, CD rates continued to rise, but with the inflation rate finally hitting the Federal Reserve's target range going into summer 2023, Americans may soon see a pause from Jerome Powell. That’s because it is expected that the U.S. central bank has reached its inflation target and can now pause before it engages in rate cuts. This was not always the consensus — just a few months ago when asked what his prediction was for this year and next, Ken Tumin, who is the founder and editor of DepositAccounts, said he believed that interest rates will continue to climb until 2023. He predicted that if the Federal Reserve raised interest rates a total of seven times during 2022, five-year CDs would rise to a range of 4.00% to 4.50% by the end of 2022, which was an accurate prediction. This high percentage yield was offered mostly by larger online banks rather than brick-and-mortar savings accounts.
Tumin predicted what he thinks will happen if the Federal Reserve is more aggressive when it comes to raising interest rates. He believes that if the Fed raises interest rates nine times in 2022 and four times in 2023, the five-year CD rate will climb to between 4.75% and 5.00% APY by the end of 2023.
No one can know for sure if CD rates will continue to rise or not in 2023, but all signs point to a rate hike pause as the Federal Reserve sees inflation rates taper off.
Why Do CD Rates Change?
So, when will CD rates go up? To make a prediction, you must understand the role of banks in determining CD rates.
With mortgage rates sitting at 6.72%, it seems that CD rates would quickly rise to catch up. After all, they are both based on the interest rate, right? Well, not exactly.
Banks control the mortgage rates and CD rates, and there is a huge difference between the two from a bank’s perspective. With mortgage rates, the bank earns a higher percentage of money when the lending rate is higher. With CDs, the bank has to pay out a higher percentage of money. Banks are more likely to raise mortgage rates based on the interest rate faster than they are to raise CD yield based on the same interest rate so they will make more profit.
Another factor that determines how CD rates change is the federal funds rate, also determined by the Federal Reserve. The federal funds rate is the interest rate that banks use to loan their excess reserves to each other overnight. When the federal funds rate is at 0%, banks use it to make loans to each other, but once it goes over 0%, banks turn to consumers for the deposits they need. They use CD rates as a way to bring in those consumers. While banks need to be competitive in the CD rates they offer to attract those consumers, they try to keep the rates as low as they can so they won’t have to pay out as much interest.
Do Treasury Bonds Pay More Than CDs?
As long as banks continue to raise CD rates in line with increased interest rates, experts like Kevin Mirabile — a professor of finance and business economics at Fordham University’s Gabelli School of Business in New York – predicted that CD rates would continue to climb and reach a peak of 2% to 3% by the end of 2022. Because the Federal Reserve kept its promise to raise rates to combat inflation, Mirabile’s projection was on target.
But he thinks that for some investors, Treasury bonds may be a better investment. Why? Because he believes the yields on them will pay more than CDs. For instance, he believed that by the end of 2022, the yield on a five-year Treasury bond would be at around 4%.
This was an accurate projection, and Treasury Bonds proved to be a favorable investment over CDs and normal savings accounts.
Mirabile said that because banks are slow to adjust CD rates when Treasury yields rise, Treasuries may yield a higher return than CDs. The reason banks are slow to adjust? They use the deposits they take in, including those from CDs, to fund loans and investments in Treasuries. If the bank can pay out a lower amount on CDs and use the earned reserves to invest in higher-yielding Treasuries, they will earn a higher profit.
Who should invest in Treasuries? If you invest in Treasuries and hold them until the maturity date, your guaranteed return will be the stated annualized yield to maturity. If you sell before the maturity date, you could take a loss, especially in today’s financial environment.
Bonds lose value when interest rates rise, meaning that since the Fed has announced it will continue to raise rates, selling Treasuries before the maturity date will likely result in a loss for the foreseeable future. But if you plan to hold the Treasuries until maturity, you are guaranteed a return, no matter what happens to interest rates — that may be a good investment for you.
Identify Useful Confluences
Predicting when CD rates will increase is difficult as they are influenced by various factors such as the Federal Reserve's actions, market conditions and banks' strategies. CD rates historically have been higher than they currently are, but experts' predictions are uncertain. Banks control mortgage rates and CD rates, and they may be more inclined to raise mortgage rates faster. Treasury bonds could be a better investment option at the moment because of potentially higher yields, but the decision to invest in CDs or Treasury bonds depends on individual financial goals, risk tolerance and investment strategies.
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Frequently Asked Questions
Will CD rates rise in 2023?
To know if CD rates will rise in 2023, you have to look at what the Federal Reserve is doing and plans to do with interest rates. It has stated that it will continue to raise interest rates well into 2023, so the chances that banks will raise CD rates are good but not guaranteed. Interest rates are tied to short-term consumer deposit rates, and while the banks will likely take longer to tie interest rates to CDs because it negatively affects their profits to have to pay more in interest, they eventually will. In short, rising interest rates will lead to higher CD rates.
Are CD rates going to go down?
At some point, it only makes sense that CD rates will go down, but as long as interest rates are rising, CD rates will also continue to rise. That’s because CD rates and interest rates are connected. So, as long as the Federal Reserve continues to raise interest rates, CD rates will follow. Once interest rates begin to go down, CD rates will also likely decline.
What is the difference between a CD and a savings account?
The main difference between a CD and a savings account is the way in which the money is invested. A CD is a fixed-term investment that offers a higher interest rate than a savings account but requires the money to be locked in for a specific period of time. A savings account, on the other hand, is a more flexible investment that allows easy access to the money but typically offers lower interest rates. Additionally, CDs usually have penalties for early withdrawals, while savings accounts do not. So if you are looking to open an emergency fund for a rainy day, a savings account or checking account are better choices due to no withdrawal penalties.
Are CDs insured?
CDs are typically insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA) for credit union CDs. It is important to check with your specific bank or credit union to ensure its CDs are insured and to understand the terms and limitations of the insurance.