A certificate of deposit (CD) has long been considered a safe place to store cash. But CD interest rates haven’t exactly been impressive. That is, until recently.
Now, the best CD rates hover around 5% APY for a 12-month term. And many savers are wondering whether they’ll continue to go up.
Knowing what rates may do in the future can help you decide the best CD investment strategy today. So if you’re thinking about putting your money in CDs, find out if rates are expected to go up first.
What causes CD rates to go up or down?
In general, CD rates are affected by changes to the Federal funds rate (also known as the Fed’s benchmark rate). This is the interest rate that commercial banks charge each other to borrow money overnight, as banks are required to maintain a reserve of cash equal to a percentage of their deposits at all times (known as a reserve requirement).
The Federal Open Market Committee (FMOC), which is made up of 12 Federal Reserve members, meets eight times per year to review the current state of the economy and make decisions related to monetary policy. That may include the decision to raise rates, often in response to rising inflation. And when the Fed raises its target rate, banks typically follow suit and increase their interest rates—including those on CDs.
That’s because when the Fed’s target rate goes up, the cost of borrowing from other banks increases. To cover the higher costs and maintain profitability, banks may raise the interest rates they charge on loans. And to fund these loans, they often need to attract more customers and grow their deposit base, which they do by increasing the rates they offer on deposits, such as savings accounts and CDs.
CDs are ideal deposit products for banks for managing their cash reserves because they have a fixed maturity date and cannot be as easily liquidated as a checking or money market account, according to Gregory Garcia, executive vice president and chief operating officer of First Commerce Bank. “Locking in deposits helps banks manage their cash flow expectations, and they are willing to pay higher rates in order to reduce cash flow uncertainty,” he says.
In addition to moves by the Fed, many banks have also been forced to raise CD rates to offset competition from higher rates paid by money market mutual funds and higher U.S. Treasury yields, says Anthony Chan, an economist and public speaker. He adds that rising CD rates have also been exacerbated by concerns that some banks are less safe because of an undiversified loan portfolio, a high proportion of uninsured deposits, or a high proportion of depositors that were inclined to withdraw money. “Banks were forced to raise rates to avoid an evaporation of deposits,” Chan says.
Finally, CD rates may also go up when the economy is growing and demand for credit increases. This can lead to higher interest rates across the board, including CD rates, as banks compete for deposits to fund their lending activities.
Conversely, CD rates tend to fall when the Fed lowers its target rate or the economy slows, as the demand for and cost of borrowing money decreases as well.
CD rates from 2010 to 2023
CD rates have been relatively flat for the past decade; interest rates were at historically low levels because of rate cuts by the Fed following the Great Recession.
At the end of 2010, the average 12-month CD rate was just 0.53%. By 2012, it had fallen to 0.23% and hovered around that level through 2017.
Just as rates were beginning to pick up again, the pandemic hit, and rates were back at rock bottom. By the end of 2020, the average 12-month CD rate was just 0.16%.
However, things changed mid-2022 when the Fed began increasing rates to combat rampant inflation. “CD rates have accelerated at a much faster pace in 1Q 2023,” Garcia says.
View this interactive chart on Fortune.com
Today, the average 12-month CD rate is 1.54%, according to the FDIC. However, many banks are offering rates of 4%–5% or more, especially for longer terms.
Will CD rates continue to rise?
Over the course of its year-long battle against rising inflation, the Fed has raised rates 10 times—most recently to a target range of 5.00%–5.25%. However, Fed chairman Jerome Powell has hinted that rate hikes may be coming to an end soon. And that could spell the end of rising CD rates.
For now, we can probably expect rates to tick up a bit more. “CD rates should continue to climb in the near future as demand for deposits continues and while the Fed continues to raise interest rates,” Garcia says.
Chan adds, "Rates on core bank deposits will only stop rising when the Fed begins to reverse course and start lowering interest rates, and the current fear in some regional banks begins to ease.”
How to make the most of today’s CD rates
Regardless of whether CD rates go up or not, you can take advantage of today’s rates and maximize your savings.
- Stick with shorter terms: Garcia notes that we’ve been experiencing a prolonged inverted yield-curve environment, meaning short-term rates are actually higher than long-term rates. So purchasing short-term CDs (e.g., no longer than two years) will get you the best yield. Plus, it’s impossible to predict exactly what CD rates will look like in the next few years, so it’s a good idea to avoid locking in your money for too long. Sticking with terms of six to 18 months will let you take advantage of today’s high rates, but give you the ability to move your money elsewhere (without paying early withdrawal penalties) if rates fall in the future.
- Build a CD ladder: Alternatively, you can consider putting your money in a CD ladder, which allows you to take advantage of long-term CD rates while maintaining some liquidity in the short-term. “A prudent CD investor may want to ladder their investments across multiple terms so that market timing doesn’t significantly impact their repricing investment upon maturity,” Garcia says.
- Hedge your savings: Deposit rates are up across the board. So depending on your financial goals and cash flow needs, you might also want to park some cash in similar low-risk investments, such as a high-yield savings account or T-bill, just to ensure you have your bases covered in case CD rates change dramatically.
The takeaway
If you’re looking for a safe place to store your savings—and earn a competitive rate so your money can grow faster—it’s hard to beat a CD. Interest rates are the highest they’ve been in about a decade, and are likely to stay elevated as long as the Fed continues raising its rate (or at least, keeps it at its current target).
However, even though we can make educated guesses about how CD rates will move in the future, it’s impossible to predict exactly what will happen. For that reason, it’s a good idea to stick with shorter CD terms of one year or less so you can easily pivot if things change. Alternatively, you can create a CD ladder if you want to take advantage of the higher rates that come along with longer terms.
Also, remember that you have to keep your money on deposit until maturity to enjoy the full benefits of a CD. Withdrawing money early will result in an early withdrawal penalty, which can easily wipe out interest earnings. So if you have emergency savings that you may need to access, consider putting those funds in a high-yield savings account instead.
