Thawing Out from a Zero Interest Rate Climate

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February 19, 2016

After seven years of near-zero interest rates, the U.S. Federal Reserve took a significant step toward normalizing monetary policy on Dec. 16. The target federal funds rate — the rate at which banks lend to each other overnight — increased by 25 basis points, to a range of 0.25 to 0.5 percent.


The Fed held the rate near zero for so long in response to a global financial crisis and recession, but this interest rate increase marks a new chapter in the life cycle of the economy.


Janet Yellen, Chair of the Federal Reserve’s Board of Governors, said the move indicates that the U.S. economy will continue to expand at a moderate pace, and the unemployment rate will keep improving.


“This increase is a vote of confidence from the Fed,” says David Mook, Chief Private Banking Officer for The Private Client Reserve. “It sends a signal about the economy, and I think it’s good news.”

What other rates will this affect?


Rising interest rates have important implications for both banks and individual investors. While borrowers likely will pay more for variable-rate loans upfront, it might be a longer period until savers receive a higher rate of return on deposits.


Floating interest rates on loans, for instance, are generally tied to an index such as the prime rate or LIBOR (London Interbank Offered Rate), Mook

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February 19, 2016

explains. These rates, in turn, tend to move with the fed funds rate. In fact, most banks raised their prime rate only a day after the Fed move. “That’s where the Fed really does have an impact on borrowing rates,” Mook says.


Deposit rates, meanwhile, are determined by individual banks, so they can take longer to move up. Mook explains that checking and savings accounts, along with money-market accounts, tend to move consistently with short-term interest rates and are likely to change more rapidly. On the other hand, certificates of deposit that mature in more than a year are more closely tied to longer-term rates, which are less affected by the Fed decision.


There are still several factors beyond the fed funds rate that determine how much a bank raises its loan and deposit rates. On loan rates, “the primary factor is clearly competition,” Mook explains.

If a bank is particularly eager to win business from a customer, it will be more likely to match a competitor’s more attractive borrowing rate.


On the deposit side, the bank’s asset and liability positions also come into play in determining rates. A bank that is hunting for deposits to fund its loans will raise its rates for savers more quickly, Mook says.


Deposit rates are also shaped by the Treasury yield curve, the line that plots the interest rates of bonds of similar quality but different maturity dates. When the yield curve is relatively flat — meaning there is little variance between shorter-term and longer-term rates — then depositors won’t get much of a premium for holdings with later maturities. Additionally, a bank’s credit rating impacts how much it needs to pay for deposits.



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February 19, 2016

Mook suggests investors consider how the Fed decision affects their own positions. For example, borrowers who have long-term, floating-rate debt might want to consider converting to a fixed interest rate before terms become less attractive.


Because interest rates are low now, and the Fed expects them to move up only gradually, for some investors, it might make sense to consider borrowing to fund a new investment.

“Often, when situations are in a state of flux, circumstances may present investment opportunities,” Mook says. “From a historical perspective, it should continue to be very inexpensive to borrow money.”


For more information, see The Private Client Reserve’s rising interest rate environment page at


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