Lower financial anxiety among consumers combined with the recent congressional ease on some of the Dodd-Frank financial reform law, and the anticipate increase in the Fed funds rate are setting up the stage for a “rate race” starting in the first half of 2015. Rate race is a behavioral finance phenomenon where interest rates start rising as a result of higher demand for loans brought by improving economic conditions,. In order to fund the increase in demand for loans, banks have to compete for consumers’ money by raising interest rates on deposits
On Saturday the 13th of December, congress passed a $1.1 trillion spending plan that includes a roll back to the 2010 Dodd-Frank financial reform law on certain types of derivatives trading by banks. This ease will make lending more attractive and profitable for banks since they can now add new revenue streams based on the loans and mortgages they issue. In order to fund the anticipated increase in lending demand, banks will need to increase rates on consumer deposits even before the Fed increases the funds rate.
The Fed is expected to increase the funds rate during their June 2015 meeting. However, based on historical data of the 1994 and 2003 cycles of rising Fed funds rate, banks started increasing their deposit rates about 6 months prior to the anticipated increase by the Fed as a preventive measure to protect their consumer deposits from going to other banks with higher interest rates. The same scenario is expected to occur in the early part of 2015.
Rate race is one of the six financial behaviors consumers engage in based on their level of money anxiety. In Behavioralogy, the science of consumer financial behavior, consumers modify their savings and spending behaviors based on high, medium and low levels of money anxiety. The six behavioralogy orientations are “mattress money, “power play”, “rate race”, “durable diet, “tiny treats” and castle craze”. The behavioralogy financial orientation matrix was developed by Dr. Dan Geller, author of the book Money Anxiety.