Inflation Cools for Tenth-Straight Month: Where Are CD Rates Headed Now?

For investors who love fixed income, 2023 has so far been the year of the CD. Rates on short-term CDs have skyrocketed from a meager average of 1.3% in May 2022 to an eye-watering 5% this April, with one CD even hitting 7%.

But if this upward climb has convinced you to wait for potentially higher yields later this year, the downward trend in inflation could leave you waiting for quite some time. Here's what the latest inflation data could mean for CD rates.

How CD rates and inflation are connected

Inflation and CD rates aren't inextricably linked. In other words, your bank doesn't offer higher CD rates just because inflation is high (they're not that generous). But inflation and CD rates do have a correlation through the federal funds rate.

The federal funds rate and national CD rates typically move in tandem. This is because whenever the Fed adjusts its funds rate, banks can earn more profit on interest, whether it's from money held overnight at the Federal Reserve, lent out to other banks, or invested in securities (like bonds). A higher funds rate means banks are generating more income on interest. This extra money incentivizes banks to offer higher CD rates as a way to bring in more depositors.

Since March 17, 2022, the Federal Reserve has combated inflation by hiking the federal funds rate from a range of 0.00% to 0.25% to one of 5.00% to 5.25%. And its strategy is working: For the tenth consecutive month, the Consumer Price Index trended downward in April, dropping to 4.9%. That's still far from the Fed's target of 2%. But the downward momentum is encouraging and it might lead the Fed to reconsider hiking rates at its next meeting in June.

Don't miss that last part: If the Fed doesn't hike rates in June, it will be the first time in 14 months that it pauses its campaign. That doesn't mean CD rates will all at once swan dive to all-time lows. But it could lead APYs to creep downward, which could make today's high rates the peak.

Could CD rates drop in 2023?

The real question here is this: Could the Federal Reserve reverse course and hike its federal funds rate downward in 2023?

It's certainly possible. And, in fact, many economists are anticipating that it will. According to the CME Group's FedWatch Tool, which compiles pricing data from 30-Day Fed Funds futures, the odds of the Fed pausing its interest hiking campaign is high -- around 87%. Likewise, the probability that the Fed will begin hiking rates downward before winter is also high, with a 43% probability in July and 48% in September.

Of course, anything is possible. But at this point the likelihood of CD rates soaring higher than their current average is slim. It would take an alarmingly high inflation rate for the Fed to feel compelled to continue hiking interest rates. Not impossible, but trends in inflation data aren't supporting it.

To be sure, CD rates are still hovering between 4.5% to 5%. But if you want to lock money into a CD, I wouldn't wait: Now might be the most opportune time to get a CD before they begin trending down. Of course, CD rates aren't falling just yet, so you still have time to shop around for the best CD rate. If you're hesitant, you could look at shorter terms -- like 3- or 6-month CDs -- then reconsider your position when that CD reaches maturity.