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TAG Talks: Understanding High Bank CD Rates – The American Consumer

Written by Dan Rodbell, Director of Investment Strategy 

Today I want to touch on a question that we’ve been hearing from some of our clients as well as people in the local community. Boiling it down to one statement, it goes something like: “Why are banks offering these high interest rates on CD’s and deposits if we are headed towards a recession?” 

As a quick disclaimer to the recession question, at The Ansardi Group (TAG) we do not possess the perfect crystal ball, so we cannot predict if there will even be a “recession” where there is broad business failure, unemployment, and other disruptions that cause economic and investment pain to the American people. As it stands right now, analysts at investment firms and banks have softened their concern about a recession. Earlier this month, Goldman Sachs adjusted their prediction to a 1 in 4 chance of recession in the next 12 months. If you click through that hyperlink, the article from Goldman Sachs talks in detail as to why they believe strengthening economic conditions have helped our chances.

In recent months the United States labor market (job seekers and job openings) has trended in the right direction with companies having success in hiring employees, which helps to reduce pressure on wage inflation (companies have to raise their offered wage to get new employees). All this hiring and good business health has also helped to keep U.S. consumers flush with cash and spending on expensive big purchases like vehicles and homes.

The Fed Funds Rate Is the Backbone of Bank Lending/Borrowing

The U.S. Federal Reserve (we’ll call it “the Fed”) is tasked with the dual mandate of achieving stable prices and to maximize employment. When necessary, the Fed manipulates The Federal Funds Rate as well as the money supply to find the right balance between those two goals. The Federal Funds Rate is the benchmark that commercial banks use to lend their excess reserves to each other on an overnight basis.

We have had really pesky inflation on the cost of nearly everything over the past few years. Fed Reserve Chairman Jerome Powell and his board of governors have precipitously raised the target overnight lending rate for banks to over 5% in just over a year’s time. In theory, raising rates reduces purchasing demand, causes companies to slow down capital investment plans, and the labor market comes into better balance as less jobs are available. Fortunately, the rapid rate increase has had some of the desired effects while also not harming the economy too drastically to this point in time. Banks look at the Fed Funds rate as their benchmark, and all lending/borrowing they do is typically based upon that number with various factors influencing how they offer/accept rates that are lower or higher.

Banks Need Deposits to Issue Loans!

The American Consumer continues to buy up ever more expensive vehicles per Cox Automotive and a retreat below 7% APR for well qualified buyers on the 30 year mortgage over the last month has increased mortgage demand. Most consumers prefer to take out loans for these purchases, and banks are happy to originate loans to them so long as they have a good credit score and collateral (the vehicle or home itself) that can be secured against the value of the loan being issued. As needed, banks will offer higher interest rates on deposits and CD accounts so that they have the available money to originate loans for those $40k+ vehicles and $300k+ homes people continue to buy. As long as the banks collect more interest from loans than they pay out to depositors, they are making money.

In a nutshell, so long as people continue to spend, banks are happy to make a profit off of them. We hope this longwinded discussion helps clarify the age-old concept that “supply rises to meet demand” in the world of consumerism.