Should You Open a CD Now, or Wait for a Better Rate?

Over the past couple of years, certificate of deposit (CD) yields have risen dramatically.

In fact, from the start of 2022 through January 2024, annual percentage yields (APYs) of high-yield CDs offered by online banks have risen from about 0.50% to about 5.35%, according to the DepositAccounts 1-Year Online CD Index, which averages the yields offered by 10 top online banks. And while the rise has been the greatest when it comes to shorter-maturity CDs, long-dated ones have risen as well. The average 5-year online CD has risen from about 0.85% to just under 4%.

With a sharp and sustained rise like this, it might seem logical to keep some money on the sidelines -- maybe in your high-yield savings account -- in case yields go up even further. However, that might not be the best idea.

Benchmark interest rates are expected to fall, not rise, in 2024

The Federal Reserve has raised interest rates significantly over the past couple of years. In an effort to combat inflation reaching its highest level in decades, the Fed raised the federal funds rate by more than 5 percentage points since the start of 2022. And this has been the key driving force behind the multi-year highs in savings account and CD yields we're seeing now.

However, inflation has been steadily falling toward the Federal Reserve's target, and nearly all experts believe the Fed is set to start cutting rates in 2024. There's a bit of disagreement as to the extent and timing of the cuts, but most experts agree that the benchmark federal funds rate will be significantly lower by the end of 2024, and lower still by the end of 2025.

According to the most recent projections from the Federal Reserve, the policymakers themselves anticipate three rate cuts this year, for a total of 0.75%. Others think the Fed will end up being more aggressive. For example, the CME FedWatch tool, which essentially tells us what investors think will happen, shows that the median expectation is for six 0.25% rate cuts this year, a total reduction of 1.5%, with the first cut expected in March.

CD yields are likely to follow the Fed closely

To be fair, CD rates aren't directly correlated with the federal funds rate, or with any other benchmark interest rate. However, they tend to move in the same direction as the Fed's rate movements, and in the case of CDs from online banks, they tend to move rather closely.

For example, in the introduction I mentioned that since the beginning of 2022, 1-year online CD yields have risen from about 0.50% to 5.35%, a difference of 4.85%. In the same time period, the Fed has increased the federal funds rate by 5.25%. With 5-year online CDs, the correlation has been a bit less, but it's still there.

The point is that if the Fed starts cutting rates in the spring, as they are widely expected to do, CD rates -- especially those of online CDs -- are likely to fall almost immediately.

There's no guarantee rates will fall, but...

To be perfectly clear, there's no guarantee that the Fed will reduce interest rates at all. If inflation were to unexpectedly spike higher, the Fed could decide to leave rates alone, or even raise them. Nobody knows for sure.

Having said that, the Fed has made it clear that it anticipates lowering rates as inflation continues to slow down, so all signs point toward lower CD yields at the end of the year than we have now. If you have money on the sidelines, and you've been waiting for the best time to put it into CDs to generate interest income -- the best time might be right now.