Lousy CD rates will squeeze savers again in 2014

Piggy bank squeezed by a vise

We found out just how low CD rates could go this year.

And it was ugly.

Now savers looking ahead to 2014 should expect those pitiful returns to hang around through 2014 — and probably 2015.

Peter Morici, an economist and business professor at the University of Maryland, sums up what the next several years has in store for us this way:

"We may see rates slightly rise in the future, but we're still a long way off from the good old days of CDs when you could earn a (safe and FDIC-insured) 4% or 5%."

Yes, indeed, the kind of reasonable returns savers can feel good about are a long way off.

As CD rates plunged lower and lower over the past five years, we often wondered where the bottom might be.

Now we know.

The average returns on six of the most popular certificates of deposit have stabilized at the record lows they reached in late spring and early summer, according to our weekly survey of major banks and thrifts.

What seemed like an endless decline in savings rates began in October 2008, when the financial industry's reckless lending led to the worst economic crisis since the Great Depression.

Average CD rates since 2008

Take 5-year CDs, for example. Savers could only watch with dismay as the average return on those investments fell from 3.5% when the financial crisis struck, to just below 0.80% last May.

But that was the end of the decline.

Over the past seven months, the average 5-year CD has paid between 0.77% APY and 0.79% APY. It's 0.78% APY in our latest survey taken on Monday.

What got it to this unprofitable point?

The Federal Reserve, of course.

The government's bank-for-banks controls short-term interest rates by establishing the federal funds rate. That's what commercial banks must pay to borrow money that other banks have on deposit with the Federal Reserve.

In December 2008, the Fed's rate-setting committee slashed that rate to essentially zero in an attempt to spur lending and boost the economy.

But by providing commercial banks with an almost limitless supply of free money, the Fed ensured they no longer needed our money, and savings rates went into a four-year tailspin.

Simple Savings Calculator

While we can all be relieved that CD rates are no longer falling, there's little chance of a serious, sustained recovery until the Fed's Open Market Committee decides to raise the fed funds rate.

In late 2012, Fed Chairman Ben Bernanke said the central bank would start bumping rates up when the unemployment rate hit 6.5%.

With that goal in mind, savers anxiously watched the jobless rate fall to 7.3% in August. Not quite there, but closing in.

Then Bernanke told a news conference after the Fed's rate-setting committee met on Sept. 18 that “the first increases in short-term rates might not occur until the unemployment rate is considerably below 6.5%."

Indeed, the Fed chairman said a return to market-driven rates — and a reasonable return on our savings — could be "several more years" down the road.

Not surprisingly, the Fed policy-making committee affirmed Bernanke's words during its December meeting, formalizing a policy to hold rates down until "well past the time" the unemployment rate falls below 6.5%. (It's at 7.0% now.)

When, exactly, might the fed funds rate start to rise?

Many economists and experts such as Bill Gross, co-chief investment officer at the giant mutual fund company Pacific Investment Management Co., or PIMCO, are now pointing to 2016.

As a result, financial adviser Jim Heafner says savvy savers should be using 2014 to position themselves to take advantage of rising rates two to three years down the road.

"It's going to happen slowly," says Heafner, the president of Heafner Financial Solutions in Charlotte, N.C., but "you don't want to lock up your money for five years in this environment."

How much do CDs pay?

Term Average APY Top deal
6-month CD 0.14% 0.90%
12-month CD 0.23% 1.10%
24-month CD 0.36% 1.25%
36-month CD 0.48% 1.45%
60-month CD 0.78% 2.16%
As of Dec. 24, 2013

The classic strategy is to go short when rates are down and have nowhere to go but up.

A longer-term CD might earn a little more now, but if you wanted to take advantage of rising rates, you'd have to break the CD and incur a penalty.

Besides, even the average 5-year CDs are only paying about a half-point more than the average 2-year CDs. In dollars-and-cents terms, that's not much.

When interest rates do start to rise, 5-year CDs will be the first to benefit.

"There is historically a sequence to the increase of CD rates," says Dan Geller, executive president at Market Rates Insight, a financial industry research firm in San Anselmo, Calif.

"We'll see it in the longer-term rates first, then the mid-term then the short-term" CD rates, Geller says. "But it's going to be slow and gradual."

One thing for sure is that the Fed won't even think about raising the fed funds rate until its campaign to drive down long-term interest rates — the return on debt that matures in 10 to 30 years — is completely over.

To do that, the Fed has been flooding the bond market with money, buying $85 billion worth of Treasury bonds and mortgage-backed bonds a month.

At its December meeting, the Open Markets Committee announced it would start dialing back those purchases, or "tapering" in Fed-speak.

In January, the Fed will only buy $75 billion worth of bonds, and further cuts are expected as the year goes on until the purchases end sometime in late 2014 or early 2015.

If you're a natural optimist, then you can think of that as the first step on a long road back to reasonable CD rates.

But we should expect returns to spend the next 12 months bumping along the bottom we hit in 2013 and positioning our investments to take advantage of higher returns a couple of years from now.

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