The Fed Is Waiting Longer Than Expected to Cut Rates. Here's What That Means for CD Yields

While inflation has cooled off significantly since its mid-2022 peak, it has proven to be a little more stubborn than the Federal Reserve would like to see. According to the most recent consumer price index (CPI) data, the inflation rate was 3.1% in January, still significantly higher than the Fed's 2% target.

This, combined with recent commentary from Fed officials, indicates that interest rates might stay elevated for longer than many experts had predicted. And this could have implications for the interest rates banks are willing to pay on CDs.

Expectations have changed a lot

The short version is that at the start of 2024, many experts expected the Federal Reserve to cut interest rates aggressively and quickly, with many expecting the first rate cut to happen at the March Fed meeting (ends on March 20) and the median expectation of six quarter-percentage-point rate cuts for the year, or a 1.50% reduction in the federal funds rate.

To put it mildly, things have changed since the start of 2024. Not only is inflation taking longer than expected to cool off, but the economic data has been surprisingly strong this year, for the most part. Plus, Fed officials (including Fed Chair Jerome Powell) have said several times that they're in no rush to cut rates until there's more clarity that inflation is under control. Of course, it's worth noting that the Fed itself was calling for just three quarter-percent rate cuts (a 0.75% reduction) as recently as December.

Now, futures markets are pricing in almost no chance of a rate cut at the March meeting, or the one after that (May). According to the CME FedWatch tool, the first rate reduction is now expected to arrive in June, plus the median expectation is for just four rate cuts this year for 1 percentage point in total.

What does this mean for CD rates?

To be perfectly clear, CD rates are not directly tied to the Federal Reserve's policy decisions. In other words, there's no rule that says if the Fed lowers the benchmark federal funds rate by 0.25% that CD rates have to fall by the same amount.

Having said that, CD rates generally tend to move in the same direction as the Fed's interest rate movements. That's why after a steep period of rate hikes in 2022 and 2023, CD rates steadily trended upward and are now at their highest level in years.

I've written before that when the Fed decides to cut rates, it would likely lead to falling CD rates as well. It won't be a perfect correlation, but it would be quite shocking if the Fed were to make four rate cuts this year, as it's expected to, and CD rates proceeded to go up, or even stayed put.

The bottom line

If the consensus expectation is correct and the Fed doesn't start lowering rates until June, it most likely means that CD rates will stay roughly where they are until at least that time. So, if you're putting money into CDs, or hoping to do so soon (say, when your tax refund arrives), you might have more time.

However, it's important to emphasize that nobody knows for sure. I've discussed the expectations, but there is still a non-zero chance that we could see a rate cut at the March or May Federal Reserve meetings. On the other hand, if inflation data is unexpectedly bad, it's possible the Fed could wait much longer to cut rates (or even increase them). After all, at the start of 2022, no notable experts were expecting interest rates to rise nearly as fast as they did.

The bottom line is that CD rates might stay at their multi-year highs for a few months longer. But that doesn't mean you should keep your money on the sidelines. Virtually nobody is expecting interest rates to go higher in the near term, so now still looks like an excellent time to shop for a CD.