As the Federal Reserve raises its short-term target interest rate, experts don’t expect yields on deposit accounts to rise as fast as lending rates or as high as they used to.
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The rate of inflation may date back to the early 1980s, but today’s returns on savings accounts and certificates of deposit are unlikely to remind savers of the levels of that earlier inflationary era.
Average rates for three-year CDs peaked in May 1981 at 18.3%. according to bankrate.com, a level about 17 percentage points above today’s record for CDs of the same maturity. And that’s like the inflation rate, measured by the consumer price indexjust reached an annual rate of 8.5%, compared to double-digit rates in the early 1980s.
Financial institutions — whether brick-and-mortar banks, online banks, credit unions, or credit card companies that offer online savings — will eventually increase returns on their deposit accounts when this happens The Federal Reserve continues to tighten monetary policy to fight inflation, as expected, but First they will raise lending rates for borrowers. Banks make money on the difference between lending rates and deposit rates, and with interest rates close to zero in recent years, the spread between these two rates has been narrow.
“As interest rates rise, banks hope to widen that spread so they can return to more profitable days. This encourages them to raise lending rates more and faster than deposit rates,” said Ken Tumin, founder of DepositAccounts.com, part of LendingTree.
Tumin says the best way to get higher rates soon is through online banking, especially if the Fed hikes rates by 0.5% in May as the markets are increasingly expecting. During the last Fed tightening cycle between 2017 and 2019, digital banks were slow to respond but eventually caught up. The Fed hiked rates up to 2.5%, and the nationwide average rate on online bank deposits rose to around 2.23%. Compared to brick-and-mortar banks, online banks have a greater incentive to offer attractive rates because the overheads are lower, but also because the competition is tougher as savers can easily switch to another institution.
Currently, the national average deposit rate for online banks is 0.50%. This compares to a national average for all federally insured banks, including brick-and-mortar and online banks, of 0.06%.
According to Tumin, rates for online savings accounts are only slightly up from last year’s lows of 0.45% because deposit rates have been above the Fed’s short-term target rate for some time, which is now in a range of 0.25% to 0 .5% is , meaning there is little reason to push yields beyond that range. Additionally, banks now have little incentive to offer attractive deposit rates, having been awash with funds since the early days of the pandemic.
Online banks are instead turning their attention to CD rates, offering higher returns for people willing to lock up their money for a year or up to five years. One-year online CD rates nationwide average 0.74%, up from last year’s low of 0.44%. The national average for five-year online bank CD rates is 1.23%, compared to 0.65% at the 2021 lows. According to Tumin, these longer-dated CDs will also benefit from the increased yields two-, three- and of five-year US Treasury bonds.
Banks are betting that the Fed’s short-term target rate will be higher a year from now. So if they can get people to buy CDs at today’s interest rates, 12 months from now, those levels could appear low. “They see an advantage in now offering a slightly higher interest rate on CDs, rather than raising savings account rates to attract deposits,” says Tumin.
Greg McBride, chief financial analyst at Bankrate.com, advises savers who want to take advantage of rising deposit rates to stop buying CDs with longer maturities. “You want interest rates to keep going up, and you definitely want inflation to come down in a meaningful way before you set those conditions,” he says.
Even slightly higher deposit rates would be eaten up by high inflation, he notes, because the real rate of return — the inflation rate minus deposit rates — is negative. McBride equates real returns to the difference between gross and net wages.
While savers should probably forget the savings rates of the 1980s, could they hope to live the heady days of the early 2000s when online banks paid close to 5%?
Be careful with requests, says McBride, noting that the Fed’s short-term target rate was hovering around 5% at the time. “If deposit yields go back to 5%, it means the Fed has had to hike rates many times and inflation isn’t cooperating. So it could be a hollow win,” says McBride.
Write to pension@barrons.com
