A certificate of deposit (CD) has long been considered a safe place to store cash. For years, CD interest rates hadn’t exactly been impressive, but they recently surged to levels not seen in over a decade. However, with the Federal Reserve's latest rate cut, this upward climb has reached its tipping point. The best CD rates, which had hovered around 5% APY for terms of six months to a year, are now starting to edge lower, and further decreases are likely in the months ahead.
Knowing what rates may do in the future can help you decide the best CD investment strategy today. Here’s what you may expect to see in the coming months.
What causes CD rates to go up or down?
CD rates are generally affected by changes to the federal funds rate, also known as the Fed’s benchmark rate. The Fed funds rate is the interest rate that commercial banks charge one another to borrow money overnight, as banks must 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), made up of 12 Fed members, meets eight times per year to review the economy's current state and make monetary policy decisions. Those decisions may include raising rates, often in response to rising inflation. When the Fed lowers its target rate, banks typically follow suit and decrease 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. Banks may raise their interest rates on loans to cover higher costs and maintain profitability. 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.
CD rates may increase when the economy grows and demand for credit increases. When credit applications increase, rate increases often follow across the board as banks compete for deposits to fund their lending activities
Conversely, when the Fed lowers its target rate as it recently did, banks often reduce their rates on deposits, including CDs, reflecting lower borrowing costs and reduced demand for deposits.
CDs are ideal deposit products for banks to manage their cash reserves because they have a fixed maturity date and aren’t easily liquidated like checking or money market accounts (MMAs), 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 to reduce cash flow uncertainty,” he says.
When the Fed rate is high, banks raise CD rates to offset competition from higher rates paid by money market mutual funds and United States Treasurys, says Anthony Chan, an economist and public speaker. He adds that in this high interest rate environment, rising CD rates have also been exacerbated by concerns that some banks are less safe due to undiversified loan portfolios and high proportions of uninsured deposits or depositors inclined to withdraw money. “Banks were forced to raise rates to avoid an evaporation of deposits,” Chan says.
However, CD rates can also decrease. For instance, following the recent rate cut by the Fed, banks may lower CD rates because of the reduced cost of borrowing. Lower demand for loans and a slower economic environment can drive these changes, making it less necessary for banks to offer high returns on CDs.
CD rates from 2010 to 2024
Historically, CD rates have been relatively flat for the past decade; interest rates were at historic lows because of Fed rate cuts following the Great Recession.
At the end of 2010, the average 12-month CD rate was 0.53%. By 2012, it had fallen to 0.23% and remained around that level through 2017.
When the pandemic hit in early 2020, rates fell to rock bottom. By the end of 2020, the average 12-month CD rate was 0.16%. This trend changed in mid-2022 when the Fed began increasing rates to combat rising inflation.
Today, the average 12-month CD rate is 1.85%, according to the Federal Deposit Insurance Corp. (FDIC). However, many banks currently offer rates of 4%–5% or more, especially for terms under two years. Here are a few institutions that regularly offer excellent CD rates:
Will CD rates continue to rise?
After a series of 11 rate hikes to combat inflation, the Fed has now reversed course with its recent rate cut, bringing the federal funds rate down to a target range of % to %.
With this initial rate reduction already in place, CD rates are expected to gradually decline. While some top CD rates may still hover between % and % APY, this is likely to decrease as banks adjust to the new, lower federal funds rate. Although still relatively high compared to past years, these rates may not hold at these levels for long.
How to make the most of today’s CD rates
Whether CD rates increase or decrease, you can still use today’s rates to maximize your savings:
- Determine whether a short or long-term CD is best for you: Garcia notes that we’ve experienced a prolonged inverted yield curve environment, meaning short-term rates are higher than long-term ones. So, short-term CDs (e.g., no longer than two years) will yield the best. Plus, predicting what CD rates will look like in the next few years is impossible, so avoiding locking in your money for too long is a good idea. Sticking with terms of six to 18 months will let you take advantage of today’s high rates but allow you to move your money elsewhere (without paying early withdrawal penalties) if rates fall. However, Frank Newman, director, portfolio construction & due diligence at Ally warns investors of reinvestment risk, which happens when rates fall after your CD matures. You might end up having to reinvest your money at a lower rate, so tying up your money for a longer period of time lets you stretch your returns over years, regardless of what happens to interest rates.
- 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 place 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.
While your current bank might not offer the best CD rates, there are banks and credit unions offering stellar rates on CDs and share certificates, regardless of where you live. Here are a few examples from around the country:
Top CD rates by term length
View this interactive chart on Fortune.com
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 in about a decade and will likely stay elevated through 2024.
While it’s clear that rates have begun to decline following the recent Fed rate cut, the future direction of CD rates remains uncertain. Opting for shorter CD terms of a year or less can provide more flexibility, allowing you to adjust your strategy if rates continue to fall, or you could go for a longer-term CD to lock in higher rates before they reduce even more. Alternatively, a CD ladder can help you lock in some of the best available rates now while maintaining liquidity as your CDs mature at different intervals.
Also, remember that you must keep your money on deposit until maturity to enjoy the full benefits of a CD. If you withdraw funds early, you’ll likely face an early withdrawal penalty, which can wipe out interest earnings. Therefore, if you think you might need to access your cash early, it’s probably wise to skip a CD and opt for a high-yield savings account instead.
