If you’re a saver, the Fed flipped you the bird this week. They dropped interest rates and introduced “quantitative easing,” two things that will make interest rates plummet. Here’s how you can protect yourself.
First, a brief monetary policy overview. When the fed lowers the target federal funds rate, the rate banks charge each other for overnight lending, they don’t just change a number on a board somewhere. They actually pump more money into the system so demand, and interest rates, for overnight lending goes down to hit their target. This worked in the past because cheaper money means more investments… but it hasn’t been working lately (the actual federal funds rate has been under 0.20% since early December according to the NY Fed). The scary part of their announcement this week wasn’t the range target of 0.00 – 0.25%, it was the part about how they’d be using “quantitative easing” to try to stimulate the economy. Quantitative easing is fancy Fed-speak for “they’re going to run the printing presses at the Mint 24/7 and start force feeding dollar bills into our hunger striking economy.” This means interest rates across the board will fall dramatically, as you may have read with mortgage rates.
If you’re a saver, this sucks because you’ll be earning less on your savings. Right now the best thing to do is to start locking in rates in certificates of deposit (CD). A CD is a product you can get at any bank, is FDIC insured, and returns a fixed rate over the term of the CD. With a CD, your principal is protected. I maintain a frequently updated list of the best CD rates of terms no greater than 18 months that currently has rates as high as 4.00% APY.
I would warn against getting a CD that is too long term (like five or ten years) because when the economy recovers, the Fed will have to deal with inflation. Whenever you start printing money, which we have been doing for the last few months, inflation is always a problem and when we have high inflation, your locked in CD will do more harm than good.
I recommend that you check with all the banks you already have accounts with first, because rates have already begun to fall so you’ll want to act quickly. Like right now. Go!
Jim writes about personal finance at Blueprint for Financial Prosperity.