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Fed Funds Rate Hike Likely In 12 Months

Market Rates Insight Report

The Fed generally raises interest rates within 12 months after deposit rates cease declining and begin turning up; such a turning point appears to be in sight.

SAN ANSELMO, Calif. - Intuitively, we think that interest rates on deposits follow increases in the Fed funds but the reverse is actually true: the Fed increases the funds rate after an initial increase in deposits rates. Why? Because the Fed constantly monitors multiple economic indicators, one of which is lending activities. When loan demand increases, it suggests an economic expansion related to housing, automobiles, business growth and hiring. Financial institutions respond by building up needed liquidity to fund these loans, which in turn creates higher demand for deposits and therefore higher deposits rates.

Dan Geller, Ph.D.
Exec. VP, Market Rates Insight

"It appears that we are now nearing the turning point in deposit rates based on the variance analysis that I provide on a monthly basis" said Dan Geller, Ph.D. Executive Vice President at Market Rates Insight, "May or June may represent that turning point, which means that we may see a gradual increase in the national average rate for deposits in the second half of this year followed by a likely increase in the Fed funds rate by mid-2014."

The latest analysis from Market Rates Insight ( shows that twice in the past twenty years the Fed initiated a cycle of decrease and increase in the funds rate. In both cases, the Fed increased the funds rate by 25 basis points (bps) 12 months after the national average rate of deposits reached its turning point, or the point at which the national average rate ceased to decline and began turning upwards.

The first incident occurred in April 1993, when the national average rate hit a turning point at the 0.00 variance mark (at 2.28% actual APY) while the Fed funds rate stood at 3.25%. Once the national average rate of deposits started increasing after the April turning point, it took the Fed exactly 12 months (March 1994) to boost the funds rate by 25 bps - from 3.25% to 3.50%. While the April 1993 rates look very high by today's standards, this actually represented a very sharp decline in rates relative to the Fed funds rate of 8.0% experienced a few years earlier.

A very similar pattern occurred in August 2003, when the national average rate reached its turning point at 0.00 variance while at 1.38% actual APY and then started climbing. The Fed funds rate at that time stood at 1.25%; 12 month later, in July 2004, the central bank increased the funds rate by 25 bps, from 1.25% to 1.50%.

This turning point of deposit rates is tracked by a variance analysis, which measures changes in the national average rate for deposits on a monthly basis. When the analysis shows a gradual decline in the rate variance, it means that the national average is nearing its turning point. When the variance reaches 0.00, no further decrease in the national average rate from the previous month to the current month has occurred, thus signaling a turning point.

About Market Rates Insight
Market Rates Insight (MRI, is a reputable provider of competitive-pricing information and analysis to financial institutions. MRI's competitive data is complete, detailed and timely, which allows for the highest level of pricing precision. Therefore, the use of MRI's competitive data ensures greater pricing optimization, and subsequently, improved profitability. In addition to competitive-pricing data, MRI also conducts pricing analysis and provides tracking of industry indexes. MRI's indexes, published weekly in the National Pricing Indicators, are the industry standard for deposit pricing, and are viewed weekly by executives of banks and credit unions through video, audio and print channels.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.