Will CD Rates Go Up When the Fed Raises Interest Rates?

Certificates of Deposit (CDs) are a savings option where individuals deposit money for a fixed period at a set interest rate. A primary influence on CD rates comes from the Federal Reserve’s actions. This article explores the connection between the Federal Reserve’s interest rate adjustments and CD rates.

The Federal Reserve’s Role in Interest Rates

The Federal Reserve operates under a mandate from Congress to promote maximum employment and stable prices, often called its “dual mandate.” To achieve these goals, the Federal Reserve employs monetary policy tools, focusing on influencing short-term interest rates.

A central tool for monetary policy is the federal funds rate, which is the interest rate at which depository institutions lend reserve balances to one another overnight. The Federal Open Market Committee (FOMC), the policymaking body of the Federal Reserve System, sets a target range for this rate. The FOMC typically meets eight times a year to evaluate economic conditions and determine adjustments to this target range.

The effective federal funds rate is the weighted average of these overnight transactions. The FOMC influences the effective rate to stay within its target range by adjusting interest paid on reserve balances and through other tools like overnight reverse repurchase agreements. The federal funds rate serves as a key benchmark within the financial system, guiding other short-term interest rates.

How Fed Rate Changes Impact the Economy

Changes in the federal funds rate ripple throughout the economy, influencing various other interest rates. When the Federal Reserve adjusts its target rate, it impacts the cost of borrowing for banks, which then affects the rates they offer to their customers.

For instance, the prime rate, which is the interest rate banks charge their most creditworthy customers, is closely tied to the federal funds rate. The prime rate moves in tandem with the federal funds rate, often staying about three percentage points higher. This benchmark influences rates on various consumer loans, including credit cards and adjustable-rate mortgages.

Savings rates also respond to changes in the federal funds rate. When the Fed raises its benchmark rate, banks increase the interest they pay on deposit accounts, including savings accounts. Conversely, a decrease in the federal funds rate leads banks to lower their deposit rates. These adjustments influence spending and saving behavior across the economy.

CD Rates and Federal Reserve Policy

The relationship between Federal Reserve interest rate adjustments and CD rates is generally positive, meaning CD yields move in the same direction as the federal funds rate. When the Fed raises its benchmark rate, banks increase the interest they pay on deposits, including CDs. This occurs because a higher federal funds rate makes it more expensive for banks to borrow from each other, prompting them to attract more customer deposits by offering better yields.

While there is a correlation, the response of CD rates to Fed actions is not always immediate or a one-to-one match. Banks have autonomy in setting their CD rates, and the extent and timing of increases can vary among different financial institutions.

Existing fixed-rate CDs are not directly impacted by Fed rate changes; the interest rate is locked in for the CD’s term. However, for new CDs or variable-rate options like bump-up CDs, the rates offered will reflect the current interest rate environment influenced by Fed policy.

Additional Influences on CD Rates

Beyond the Federal Reserve’s monetary policy, several other factors independently influence the rates offered on Certificates of Deposit. Individual bank liquidity needs play a role, as a bank requiring more cash to fund loans or meet regulatory requirements might offer higher CD rates to attract new deposits. Conversely, if a bank is flush with deposits, it may have less incentive to offer highly competitive CD rates.

Competition among banks for deposits also significantly impacts CD rates. Online banks and smaller institutions provide more competitive yields compared to larger traditional banks, partly due to lower overhead costs and a greater need to attract new customers. This competitive pressure can drive up rates across the industry.

The overall economic outlook and inflation expectations also factor into CD rate determinations. When investors anticipate stronger economic growth or higher inflation, Treasury yields rise, which in turn influences CD rates. Conversely, economic uncertainty or expectations of rate cuts can push yields lower. These various influences mean that CD rates may not always align perfectly with Federal Reserve policy.