Fed will hold rates down until unemployment hits 6.5%

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As recently as October, the Federal Reserve was saying it would keep interest rates at record lows until at least mid-2015.

Today the Fed's rate-setting committee said it had a better idea.

It will hold interest rates down until the unemployment rate falls to at least 6.5%.

The Fed's projections say that could happen as soon as 2014, but probably not until sometime in 2015.

So it's way too early to tell if this will delay a return to more reasonable rates or perhaps speed up the process.

It also tells savers what it will take for the Fed to change the punishing policy it's been pursuing the past four years and that's made it virtually impossible to earn a decent return on short-term investments such as certificates of deposit and money market and savings accounts.

"I think the Fed has been very clear in its policies and its desire to keep easy monetary policy until our economy gets some traction and specifically the job market gets back to more historical levels of unemployment rates and labor market participation," Troy Logan, managing director and senior economist at Warren Financial Service in Exton, Pa., said after the announcement.

"We just haven't arrived there yet," Logan said, "so the Fed has been true to their word to continue with easy monetary policy."

Chart showing U.S. unemployment rate since 2008

It took nearly three years for the unemployment rate to finally fall from its peak of 10.0% in October 2009 to below 8.0% this fall.

The unemployment rate reached 7.7% in November, the Labor Department announced last week, the lowest it's been in four years.

But 6.5%?

It hasn't been that low since the financial crisis struck in October 2008 and, with only 146,000 jobs added to the workforce last month, this isn't the kind of robust expansion that instills confidence we'll get there anytime soon.

Bill Gross, the managing director of PIMCO, the giant bond fund company, said in his firm's December newsletter that unemployment could be stuck about 7% for the next decade.

Gross was only a little more optimistic when interviewed on CNBC today, saying it would take at least four to five years to lower the unemployment rate to 6.5%.

But the current rate of decline in the unemployment rate would get us back to 6.5% about when the Fed predicts.

It has dropped 0.8 percentage points so far this year, or an average of about 0.7 percentage points a month.

At that rate, the unemployment rate would reach 6.5% in 17 months, or around April 2014.

A reversal in the Fed's interest rate policy can't come too soon for all of those savers (often seniors) who need reasonable interest rates (think 3% to 4%) to keep a roof over their heads, food on the table and maintain a modest and dignified standard of living.

"These policies have really hurt savers," Logan said. "If you look at rates, they've essentially been driven down to zero. The intent is that the Fed wants to push savers out into riskier asset classes to encourage investment and thereby grow the economy."

The Federal Open Market Committee influences how much we make on our deposits by setting what's called the federal funds rate — the interest rate banks pay to borrow money that other banks have on deposit with the Federal Reserve.

It's been essentially zero since December 2008, and now the Fed says it will continue to provide the nation's commercial banks with all the money they need, essentially for free, until the unemployment reaches what it considers to be an acceptable level.

Since the government-controlled bank adopted that policy, the banks haven't needed to pay consumers for their deposits, cutting the return on those accounts to nearly nothing.

Bernanke contends this sacrifice is worth it.

In general, "healthy investment returns cannot be sustained in a weak economy," he said during a September news conference. "And, of course, it’s difficult to save for retirement or other goals without the income from a job. Thus, while low interest rates do impose some costs, Americans will ultimately benefit most from the healthy and growing economy that low interest rates help promote.”

But most savers would argue that they're being unfairly singled out and forced to live on less for a very long time.

Look at what’s happened to average CD rates since the federal funds rate was cut to 0% on Dec. 16, 2008.

Average CD Rates, 2008 vs. Today

  • Term

    December 2008 (APY)

    December 2012 (APY)

    Record Low

  • 3-Month CDs

    1.58%

    0.13%

    0.13%

  • 6-Month CDs

    1.93%

    0.19%

    0.18%

  • 1-Year CDs

    2.30%

    0.29%

    0.29%

  • 2-Year CDs

    2.39%

    0.45%

    0.45%

  • 3-Year CDs

    2.57%

    0.56%

    0.56%

  • 5-Year CDs

    3.13%

    0.92%

    0.921%

  • Record rates refer to the lowest rates recorded in Interest.com’s weekly survey of major banks and thrifts.Source: Interest.com survey of Dec. 5, 2012

Here's how that has devastated the earnings power of the typical saver.

If you had $10,000 invested at 3.13%, the average return on 60-month CDs in late 2008, you would have earned more than $300 a year.

Invest that same $10,000 at 0.92%, the average return on 60-month CDs today, and you'll make less than $100 a year.

With the average return on all six of those CDs at or near record lows this month, savers who must replace maturing CDs will be suffering from the Fed's policy for years to come.

Indeed, the very best deals you'll find at banks and credit unions don't come close to the average rates savers could earn three years ago and can't keep up with the very modest inflation we've been experiencing.

Contributing editor Craig Guillot provided information for this report.