What Happens to CD Rates When the Fed Pauses?

The Federal Reserve has hit the pause button on rates, with further increases off the table for now. After hiking the fed funds rate nine times in the three years between December 2015 and December 2018, the Fed has adopted a “wait-and-see approach” in regards to future rate adjustments.

In their own words, FOMC officials are patiently waiting for more economic data — strong or weak — to signal the need for either more rate hikes or a possible rate decrease.

This news is sweet relief for homebuyers shopping for mortgages and folks carrying credit card balances. But what does the Fed’s big pause mean for savers? Looking at historical trends can help us answer this question.

DepositAccounts has taken a look at the last time the Fed started — and then abruptly stopped — raising the fed funds rate, back in the 2004-2006 period, and examined how certificate of deposit (CD) rates responded.

Key findings

• After the Fed paused their rate hike cycle in July 2006, CD yields continued to increase for a few weeks, as you can see in the chart below. Yields on 1-, 2- and 5-year CDs remained higher for eight to 12 weeks after the Fed paused rates. Yields on 5-year CDs started to drop in late August, while 1- and 2-year CD yields dropped in September.
• The shorter-term 6-month CD fluctuated more, but remained higher overall for more than a year, with yields finally dropping in September 2007 below where they had been when rates paused. The Fed finally cut rates in the face of the deepening financial crisis in September 2007.

• Check out the following chart to see how CD rates have stayed higher, albeit slightly, following the current Fed pause. The average 6-month CD APY has increased the most, reaching an increase of 0.07 percentage points in April 2019.

Historical CD yields and the federal funds rate: 2006 to today

Back in June 2004, the federal funds rate started at 1.00%. Over the following two years, the Fed increased rates 17 times in quarter-percentage-point increments, finally pausing in June 2006 after reaching 5.25%. Fed policy is illustrated as the red line in the graph below.

In the following chart, you can see how closely CD rates corresponded to the federal funds rate during both the rate hike cycle and the following policy pause. The 6-month CD in particular rocketed from 1.3% APY in June 2004 to around 4.7% during the pause.

CD rates have responded much more sluggishly to the latest series of Fed rate hikes, starting from a floor of 0.25% in December 2015, seen in the chart below. CD rates failed to catch up to the fed funds rate before the pause. Even the 5-year CD average saw little change, despite having started higher than the federal funds rate. Of course, it’s important to note here that these rates are rising from the level where they spent the Great Recession, making for a very different economic and monetary backdrop compared with 2006.

What to expect from today’s CD rates

While it looks like CD rates are holding steady on the whole, the best CD rates may have already dropped past their prime.

“The big internet banks have been slower to move on their online CDs, but in the last few months, we've seen several of them cut rates 5 to 15 basis points on several of their CDs,” said Ken Tumin, founder of LendingTree-owned DepositAccounts.com.

However, overall rate averages tend to be watered down by banks with low rates, therefore, they don’t always capture the full range of rates very well. Tumin adds that many of those low-rate banks probably lag the Fed by several months, meaning we probably haven’t seen all the industry’s rate cuts quite yet.

When looking back to 2006 for comparison, Tumin found that 1-year and 5-year CD rates from many of the top banks did drop from June to December 2006, the first half of the Fed’s pause period. Some 1-year CDs even ended up with higher rates than their 5-year counterparts in December.

Interestingly, savings and money market rates increased during this period while CD rates fell, which we’re also starting to see now. Savings account rates are still rising slowly at several internet banks while CD rates are slowly falling.

What if the Fed cuts rates?

The last time the Fed shifted from interest rate hikes to rate cuts was in September 2007, as the financial crisis was gathering steam. At that time, it reduced the federal funds rate from 5.25% to 4.75% (nine more cuts arrived over the next 14 months). From August to November of 2007, 6-month CD yields fell from 5.40% to 4.85%. Although the CD rate drop wasn’t immediate, the 55 basis point drop nearly mirrored the 0.50 basis point rate cut by the Fed.

“One thing to learn is that you may regret not locking into long-term CDs,” Tumin warned. “When the Fed finally started cutting in 2007, the rate cuts came quickly.” From 2007 to 2008, the Fed had cut the federal funds rate target to 0-0.25% in just over a year. Savings and CD rates followed until you couldn't even get a 1% savings account or a 2% CD, closing the window of opportunity for high-yield savings.

We’re not yet at the point where we’ve completely missed out on the best rates, as monetary policy has only been paused for now. However, the Fed’s March economic forecast hinted at a possible rate cut in 2019, projecting this year’s federal funds rate to be 2.4%, below the current upper limit of 2.5%.

Note that fed funds futures are pricing in a nearly 70% probability of a July rate cut and a nearly 60% chance of three rate cuts this year, as markets appear to believe that a trade war with China or a global economic slowdown could force the Fed’s hand.

The Fed’s pause has certainly caused a drop in CD rates among industry leaders, although the averages still show little change in rates overall. Still, if we’re going to learn anything from history, there’s still time to lock in today’s CD rates before a rate cut drives rates down even further.

Methodology

DepositAccounts compared CD rates of varying maturities to the Federal Funds rate in two rising rate environments. The first period lasted from June 2004 to September 2007. The second period stretches from December 2015 to the present. Using this data, we noted the similarities and differences between the two periods.