The Federal Reserve is reportedly developing a plan for 2012 that will increase their transparency with regard to target interest rates. Their hope is that they will provide some stability to financial markets by easing concerns about borrowing costs. If people know that the cost of borrowing will remain low for years to come, it helps ease underwriting concerns that lenders have and convinces more people to take out loans to build businesses.
The Fed is an organization that, by merely hinting at things during press conferences, can send markets rallying or tumbling, depending on the hint. Transparency is an interesting move, but given people’s massive distrust of the organization (father and son Libertarian legislative duo Ron and Rand Paul have recently introduced a bill to audit the Fed), it seems necessary – especially in light of recent discoveries made by Bloomberg News regarding its secret lending programs.But what does all of this transparency mean for savings account interest rates? Won’t this have some effect?
Low Rates Aim to Stimulate the Economy
The Federal Reserve has been keeping rates historically low these days, in an effort to do what they can, through monetary policy, to stimulate the economy. By keeping short- and long-term yields low, the idea is that people and corporations will find more economically productive uses for their cash, rather than keeping it in bonds (if you’re a corporation) or savings (if you’re an individual).
We know right now that the Fed will be keeping interest rates low until mid-2013, though markets are predicting that they will stay near zero until 2014. What if you knew that the Fed would keep the market rate near zero until 2016? And what if banks knew the same?
What If We All Knew Where Rates Were Going?
Isn’t it likely that certificate of deposit products, given their inflexibility, would look much less enticing? Especially long-term CDs, which typically boast higher APYs than their shorter counterparts, would probably look a bit flatter. There would be little incentive for banks to compete for your cheap cash now by offering higher APYs when they know that it will be just as cheap in 2016.
And on the flip-side, you’ll have little incentive as a consumer to lock up your cash in products with such uninviting interest rates — but you won’t have anywhere else to go.
If banks know that in three years interest rates will be going back up, they’ll have to compete for your cheap cash right now, and we’re guessing they’d do that by introducing products with rate increase options, which give customers the opportunity to raise their CD rates to the market rate should rates go up (Ally Bank and CIT Bank currently offer such CDs).
Or, perhaps, banks could mirror the Fed’s transparency and offer a more clearly structured CD product with built-in rate increases that coincide with the Fed’s target rates. If this is the case, the transparency could really work out well for consumers.
That said, the economy is still in the doldrums, and the increased transparency likely won’t lead to better rates or terms for savers any time soon.