How did the financial markets respond to the Federal Reserve Board’s decision to lift its discount rate from 0.50% to 0.75% last week? And what does that mean to certificate of deposit rates?
In general, the stock and bond markets reacted positively to the largely symbolic move. On Friday, February 19, the day the rate hike was announced, the Dow Jones Industrial Average rose 9.45 points. Not breathtaking, but certainly not a raging indictment against the Fed’s “trial balloon” signaling the economy might be improving – and that more interest rate hikes might be on the way.
Meanwhile, Treasury bond yields receded slightly on Friday, but have been on a steady upward march for the past few weeks, thus sending a message from the bond market to the populace that some of the economic fog that has hovered over the U.S. economy since late 2008 has indeed lifted. In medical terms, the Fed’s move is akin to an emergency room doctor taking the patient off life support. Certainly, the patient isn’t out of the woods yet, but the first step has been taken to indicate the “emergency” might be over.
For the long-term, that means CD rates should creep back upward, with emphasis on the term “creep”. If the Federal Reserve’s discount rate hike is indeed a signal from the economic powers-that-be that the wind, albeit a weak one, is at our backs, then look for more rate hikes and higher CD rates in the coming months. But it will likely be slow going.
One big reason why CD rates would follow the path of higher interest rates is the stock market. If the economy is getting measurably stronger, and we’d need to see more data from the housing market, from consumer spending, and from employment numbers, then the stock market should strengthen. When that happens, banks will be forced to hike deposit rates to stay competitive, as many investors flee from safe haven vehicles like CD’s to higher-risk, but higher-reward stocks.