On Wednesday, the Federal Reserve announced that it would maintain the benchmark funds rate, indicating the potential for interest rate cuts in the future, although not in the immediate period. Financial experts have weighed in on the situation, providing insights into the timing and potential impact of rate cuts.
Possibility of Rate Cuts in May
According to Rick Rieder from BlackRock, interest rate cuts are unlikely to occur in March but may be possible in May. This insight suggests that while rate cuts are on the horizon, they may still be a few months away. Greg McBride, Chief Financial Analyst at Bankrate, concurs with this sentiment, stating, "The Federal Reserve is getting closer to the first interest rate cut, but we're not there yet."
Potential Impact on Certificates of Deposit Yields
In recent years, thanks to a series of rate hikes since 2022, certificates of deposit (CDs) have offered attractive annual percentage yields (APYs), reaching levels not seen in over a decade. However, if the Federal Reserve opts to reduce rates, experts predict that CD yields will become less impressive.
While all maturity CDs will be affected by rate cuts, the timing and magnitude of the impact will vary. McBride explains that longer-term CDs will experience declining yields well before the Federal Reserve actually implements rate cuts. On the other hand, returns on shorter-term CDs will decrease in closer correlation with the actual rate cuts.
Ken Tumin, senior industry analyst at LendingTree, supports this view by stating that when the Federal Reserve initiates policy rate reductions, short-term CD rates are likely to decline across the board. However, the impact on long-term CDs will be less pronounced, as their rates would have already experienced significant declines leading up to the first rate cut. It is worth noting that economic conditions leading to rate cuts, such as declining inflation rates and weak job numbers, often contribute to the decline of long-term CD rates, even if the first rate cut is several months away.
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Short-Term CD Rates and the Impact of Fed Interest Rate Changes
Short-term CD rates are heavily influenced by changes in the Federal Reserve's interest rate policies, according to Marcel Miu, a certified financial planner at Simplify Wealth Planning. These policies particularly affect yields that are below one year, which in turn significantly influence short-term CD rates more than long-term CD rates.
The CD market has already experienced some changes, as Daniel Carey, head of finance and accounting at Cambridge Savings Bank, points out. In anticipation of a rate cut in 2024, CD terms have been shortened to align with potential actions by the Fed. Consequently, some of the highest paying CDs now offer very short terms, such as three months at a rate of 5.5%.
Looking back at the past few months, it becomes evident that both short-term and long-term CD rates have been gradually decreasing since November. This trend likely reflects the expectation of future interest rate cuts in 2024. However, it is important to note that accurately predicting interest rate movements for the remainder of the year is challenging.
Considering the economic forecast, it may be advantageous in the long run to secure a higher rate through a long-term CD. Lionel Poudevigne, head of deposit pricing and portfolio management at KeyBank, emphasizes the need to assess the entire curve of interest rates and how long the Fed will continue to lower them, rather than solely focusing on how low they will go.
While short-term CD rates currently offer attractive returns, it remains uncertain where they will stand in a year's time. Poudevigne suggests that by locking in a long-term rate today, even if it is lower than the current short-term rate, investors can secure that rate for an extended period. This strategy proves beneficial, especially if there is a possibility of rates dropping faster than previously anticipated.
Aside from the Fed, other factors also influence CD rates. Competition among banks in a particular area plays a significant role in rate determination. As Daniel Carey explains, when multiple banks compete against each other, they tend to keep rates higher in order to attract customers away from their rivals.
In summary, understanding the impact of Fed interest rate changes and considering various factors in the market is essential when making decisions about short- or long-term CD investments. While short-term rates may be favorable at present, a comprehensive evaluation of the overall economic landscape and the potential for future rate decreases should guide investors in choosing the most advantageous option.