Federal Open Market Committee Will Send Interest Rates Higher in 2014

Over the past several years the Federal Open Market Committee (FOMC) has driven bond yields, CD rates, mortgage rates and all interest rates down to record lows. The FOMC has done this by keeping the federal funds rate near zero percent since late 2008, bought long term U.S. Treasuries and mortgage-backed securities.

The FOMC's policies in recent years have been unprecedented and has infuriated many who believed the policies were fanning inflation. The inflation hawks have quieted down after several years of screaming about the FOMC fanning inflation and creating market bubbles in financial assets. I could see why many are afraid of another bubble after the stock market bubble of the late 1990's and the real estate bubble in the 2000's.

Could the naysayers be right about inflation? Probably not, since there is still so much "slack in labor and product markets," Fed-speak for high numbers of unemployed people and low factory utilization rates. The unemployment rate will fall from current levels between now and 2014 but not to the point of causing high inflation.

Beside keeping the fed funds rate near zero percent, the Federal Reserve has also been buying interest-bearing assets to drive interest rates lower - to the tune of $85 billion a month recently. The Fed has bought so much they have a balance sheet of these assets totaling over $3 trillion dollars. One bright point everyone can agree about the Fed's actions is that they have made hundreds of billions of dollars over the past several years, helping lower the federal deficit.

Eventually the fed will have to sell these assets and unfortunately, it will sell U.S. Treasuries at a loss to unwind their balance sheet. Another negative when the fed starts selling Treasuries is their actions will send long term bond yields higher. 10 year Treasury yields have already moved higher from a record low of 1.40 percent in July 2012 to just under 2.00 percent today.

Higher Treasury yields are welcome news for investors who buy Treasuries and hold them until maturity. Higher bond yields will eventually send interest rates higher as well. This is also welcome news for investors and especially retirees who rely on interest income in retirement. Right now the best CD rates on 1 year certificates of deposit are just above 1.00 percent.

Longer term certificates of deposit don't pay much higher of an interest rate than shorter term certificates of deposit. Currently, the highest CD rates on 5 year certificates of deposit are just below 2.00 percent. Not much better than 1 year rates. Thankfully there is hope for higher interest rates in the future.