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"Exceptionally Low Rates for Extended Period" Continues - Best Options for Savers?

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The FOMC policy meeting ended this afternoon, and the press release looks very similar to April's press release. The Fed continues to say the same thing about keeping the federal funds rate exceptionally low for an extended period:

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The FOMC painted a less rosy picture of the economic environment as compared to April. There was no mention of housing starts edging up and it alluded to the debt problems in Europe as a cause for financial conditions becoming less supportive of economic growth. In addition, the FOMC noted that "underlying inflation has trended lower" unlike in April when it just said "longer-term inflation expectations stable".

The one positive sign for those hoping for a rate hike in the not so distant future is that Thomas Hoenig again voted against this policy. He remains the lone dissenter with the same reasoning as before:

Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee’s flexibility to begin raising rates modestly.

How Long is an "Extended Period"?

The question for savers is how long is an "extended period". If it's going to be 5 years, then it can make sense to favor more 5-year CDs rather than savings accounts. If it's going to be 6 months, you may want to favor savings accounts more. Another factor is the growing government deficits and the affect on long-term interest rates. The reader Mike pointed out in the forum this commentary by Alan Greenspan in which he warns against losing a sense of urgency to rein in budget deficits. In the commentary Greenspan makes the point that long-term interest rates could rise fast at some time in the future:

I grant that low long-term interest rates could continue for months, or even well into next year. But just as easily, long-term rate increases can emerge with unexpected suddenness. Between early October 1979 and late February 1980, for example, the yield on the 10-year note rose almost four percentage points.

So I'm afraid this doesn't make it any easier for us savers. If rates rise sharply like what Greenspan described, you will regret those long-term CDs. On the other hand, if rates stay low like they have been in the last two years, you may wish you had opened more long-term CDs. In my opinion, the best way to deal with both possibilities is a long-term CD with a small early withdrawal penalty. Ally Bank's 5-year CD which has only a 60-day interest early withdrawal penalty is one example. I have more details about this early withdrawal penalty in this Ally Bank blog post.

Future FOMC Meetings

If you want an idea about what the market thinks regarding when the Fed will start hiking rates, check out this CME Group FedWatch tool. It shows you the probability of rate hikes in the future FOMC meetings based on the 30-Day Fed Funds futures prices. The final four FOMC meetings for 2010 are scheduled for August 10, September 21, November 2-3 and December 14.



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