Prediction: Here's Where CD Rates Are Headed Over the Next Year

After a string of inflation and employment data that shows the U.S. economy is clearly cooling off, the Federal Reserve is widely expected to start lowering interest rates at its September meeting. And many experts now think the pace of rate cuts could be more aggressive than previously expected.

While it's true that CD rates don't directly depend on the benchmark interest rates set by the Federal Reserve, they tend to move in the same direction over time. So, here's a rundown of the latest interest rate expectations and what I think they could mean for CD rates.

The latest interest rate expectations

The Federal Reserve policymakers issue their own interest rate projections four times a year, but I prefer to use the CME Group's FedWatch tool.

Without getting too technical, this is an indicator of the interest rate moves that are being priced into the financial markets -- in other words, it is the collective expectation of investors.

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As of this writing, here's what the FedWatch tool is indicating:

• There's a virtual certainty that the Fed will lower the benchmark federal funds rate by at least 0.25 percentage points at its September meeting. (Note: One "fed rate cut" refers to a 0.25%, or 25 basis point reduction, unless otherwise noted.)
• The median expectation is for a total of 75 basis points (0.75%) in rate cuts by the end of 2024.
• By September 2025 (the latest date predicted by the CME tool), the expectation is for a total of 2 full percentage points of rate cuts from the current level.

Here's what I think will happen

Assuming the Federal Reserve rate cuts proceed according to the expectations discussed earlier, here's what I think it will mean for CD rates. It's a two-part prediction.

Impact on shorter-term CD rates

First, shorter-term CDs (say, 18 months or shorter) tend to track current benchmark interest rates. This is why 1-year CDs can be found with yields greater than 5.00% right now, but it was tough to find one that paid more than 1.00% just a couple of years ago.

So, if the Fed cuts interest rates by 2 full percentage points by September 2025, I would expect roughly the same impact to short-term CD yields. Instead of 1-year CDs in the 4.50%-5.00% range, you might see 2.50%-3.00% by the end of next year.

Impact on longer-term CD rates

Second, longer-term CD rates (two years or more) tend to track longer-term expectations of interest rates, and these tend to change much more slowly -- and in a more narrow range. This is why 5-year CD rates haven't changed nearly as much as short-term CD rates over the past few years.

If the Fed cuts rates as expected, it would almost certainly result in lower long-term CD yields than are available today. But the move wouldn't be nearly as dramatic. On 5-year CDs, 4.00% yields are readily available from the top online banks today, and this might gravitate toward the 3.00%-3.50% range by the end of 2025.

That brings me to yet another prediction -- that long-term CDs will once again pay more than short-term CDs, which definitely isn't the case right now.

As a final thought, it's important to take my predictions (and any others you might read) with a big grain of salt. Despite what some experts might suggest, nobody knows for sure what the Fed will do over the next year or two, and what exactly it will mean for CD yields.