After seven long years, the Fed finally ends its Zero Interest Rate Policy (ZIRP) by raising its target federal funds rate by 25 basis points. Exactly seven years ago, the Fed lowered the target for the federal funds rate to a range of 0 to 0.25%. Since that time, savers have suffered from extremely low rates on their deposit accounts.
ZIRP was supposed to stimulate the economy by encouraging people to take out loans and spend money. In my opinion, it’s questionable if ZIRP really helped the economy. If it did, it took a very long time to have any impact. There is one certain thing that resulted from ZIRP: it did rob savers of billions of dollars in interest from their savings.
Now that ZIRP is history, what can savers expect? First, let’s review the FOMC statement that was released today. Below is the key paragraph announcing the rate hike:
The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent. The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.
As Fed Chair Janet Yellen has mentioned several times this year, the pace of future rate hikes will likely be gradual. This is mentioned farther down in the statement:
The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
Thus, savers shouldn’t expect interest rates to rise quickly. The best we can expect is probably a Fed rate hike at every other FOMC meeting, and that will depend on consistent economic improvements. Thus, if we’re lucky, the federal funds rate may be around one percentage point higher this time next year.
In addition to the FOMC statement, the Fed also released its economic projections which include members’ expectations about future federal funds rates. Those expectations are listed in the dot plot in figure 2. As you can see in the dot plot, the average expectation for the federal funds rate is around 1.5% by the end of 2016, around 2.5% by the end of 2017, around 3.25% by the end of 2018 and around 3.5% in the longer run. The federal funds rate had been 5.25% in 2006 and 2007. Thus, it’s unlikely that we’ll see a return to the 2007 deposit rates (with savings account rates over 5%) any time soon.
Now that the federal funds rate has finally increased, how will banks respond? And how will they respond next year after additional rate hikes? On average, banks may be slow to respond. First, it has been reported that banks don’t have a strong need for deposits. As the economy improves and loan demand increases, that should change. Second, banks may focus more on restoring their interest rate margins than attracting deposits. Low rates have hurt banks by shrinking margins between their deposit rates and their loan rates. Thus, most banks won’t be in a rush to raise their deposit rates.
Even though most banks may be slow to respond to the Fed rate hike, I think it’s likely we’ll see significant rate hikes in the next month at a few banks and credit unions. Internet banks should be the first to respond. They’re the ones that are impacted the most by interest rate competition. If you want to quickly benefit from the Fed rate hike, you may have to move your money to the few banks and credit unions that are following the Fed.
Future FOMC Meetings
The next three FOMC meetings are scheduled for January 26-27, March 15-16 and April 26-27. The March meeting will include the summary of economic projections and a press conference by Fed Chair Yellen.