Going into 2013, it seemed likely that this would be the year when interest rates finally started rising. That outlook was half right: Today's mortgage rates are nearly a full percentage point higher than they were when the year began, but savings account rates are virtually unchanged.
This is a losing proposition for consumers -- mortgage loans have become more expensive, but savings accounts are no more rewarding. Will 2014 be any better? While some factors do point to higher interest rates in the new year, mortgage rates are still likely to climb faster than deposit rates.
Today's rates from a historical perspective
A quick look at history helps put today's rates in perspective. Mortgage rates may have climbed by about 1 percent in 2013, but they are still unusually low. Thirty-year mortgage rates ended November at 4.29 percent, but they have averaged 8.57 percent since the early 1970s.
Deposit rates are in an even greater depression than mortgage rates. One-month CD rates have averaged 5.82 percent historically, but as of the end of November, the national average was just 0.06 percent.
So far, deposit rates have fallen farther and stayed down longer than mortgage rates. This difference in rate behavior means that consumers not only have to watch the movements of the rates themselves, but also the spread between those rates. The wider the spread between mortgage rates and deposit rates gets, the worse conditions are for consumers.
Three influences on interest rates
What will determine the movements of interest rates in 2014? Here are three key influences:
1. Consumer demand. While the government and businesses have an effect on the economy, ultimately it is consumers who really determine its health. The anemic state of the economy in recent years reflects the weakened state of the American consumer: high debt levels, high unemployment, and until recently, depressed asset values in stocks and real estate.
The picture is somewhat improved heading into 2014. Mortgage debt has dropped by $1,296.7 billion since 2009, while other forms of consumer debt have increased by $498.2 billion, for a net debt reduction of $798.5 billion. Meanwhile, lower interest rates have eased the burden of this debt, especially for homeowners who took advantage of low refinance rates. Also since 2009, unemployment has dropped from 9.9 percent to 7.3 percent. Stock values have bounced back strongly, and real estate has begun to recover as well. A stronger consumer means more demand for capital, which should translate to higher interest rates.
2. Inflation. Over the past 50 years, inflation has averaged 4.13 percent a year. Over the past five years, that average has been just 1.52 percent. Interest rates may rise as consumer demand improves, but as long as inflation remains firmly under control, expect interest rates to stay below their historical norms.
3. Federal Reserve policy. To a large extent, Fed policy will be guided by the two influences discussed above. However, the Fed has taken such extraordinary measures to reduce interest rates that it is worth separately considering the impact of reducing those measures. The Fed influences short-term interest rates through its control of the federal funds rate, and has taken the additional step of influencing long-term rates by making regular purchases of Treasury and mortgage-backed bonds. Recent comments from the Fed suggest that it may start reducing those asset purchases before raising the federal funds rate, which would push long-term rates up sooner than short-term rates.
Put these three influences together, and the picture that emerges for 2014 is one of rates that are rising but likely to stay below historical norms, with long-term rates rising more than short-term rates.
Three impacts of higher rates
What does all this mean for consumers? Here's what you can expect to find from three different types of rates if the above scenario plays out:
1. Deposit rates. By the time 2014 is over, the rising rate environment should begin to affect bank rates on CDs, savings and money market accounts, but the overall impact may be a little disappointing. First of all, these are short-term interest rates, and long-term rates look more likely to move than short-term rates. Also, banks have little incentive to raise deposit rates. The have had no trouble attracting deposits despite low rates, and with weak loan demand, banks have had relatively little use for all the deposits they do attract. This could begin to change though: With bond yields rising and the stock market soaring, more dollars may be lured away from low-paying deposit accounts, and if loan demand picks up, banks may get more interested in attracting deposits to fund those loans.
So, expect these bank rates to rise, but slowly and grudgingly. Keep an especially close eye on long-term CD rates: Spreads between long-term CD rates and savings account rates have become more compressed as rates have dropped, so expect them to widen as rates rise. This may make long-term CDs a compelling option by the end of 2014, especially if you can find ones with mild early withdrawal penalties, which would allow you to keep your options open should rates continue to rise.
2. Mortgage rates. After rising earlier this year, mortgage rates essentially paused from August through November, but if the economy continues to strengthen, expect another leg upward for mortgage rates. This means adjustable-rate mortgages are to be avoided, but 15-year mortgages might become increasingly attractive if 30-year rates continue to climb faster than shorter-term mortgage rates.
3. Credit card rates. Credit card companies never got the memo about falling interest rates -- on average, they declined by less than half a percent from the end of 2008 through late 2013. Having not fallen so far, it would seem credit card rates are likely to rise less than other interest rates, and there is a fundamental logic to their more muted reaction to the interest rate cycle. Unlike mortgages, credit cards are not backed by any collateral, so credit card rates are especially sensitive to credit quality concerns. These concerns rise in a weak economy, which offsets the natural tendency of rates to fall at such times. Conversely, improving credit quality in a strengthening economy could largely offset the natural tendency of rates to rise.
With rates on the move, expect a wide range of reactions from different banks, making 2014 an especially important time for consumers to stay informed. The growing spread between mortgage rates and deposit rates will make the banking environment more challenging for consumers, but those who compare competing mortgage quotes and shop for the best savings account rates will be able to make the most of this environment.