Federal Reserve, the Economy and CD Rate Forecast - Jan 14, 2020

The first FOMC meeting of the year is scheduled to start just two weeks from today, and all indications point to a continuation of the Fed's decision in December to hold rates steady.

The December jobs report that was released on Friday should have no effect on the Fed’s policy. The increase in new jobs was a little below expectations, but the unemployment rate remains at 3.5%, a 50-year low. Wage growth was also below expectations. The wage growth increase for the year fell from 3.1% to 2.9%. This should give the Fed more reasons to hold rates steady. Economist Tim Duy summarized his view of how the jobs report will impact the Fed in his latest FedWatch blog post:

Mostly [this labor report] is a continuation of recent trends that will encourage the Fed to retain their basic optimism while providing them no reason to change course. Probably most important for policy was the weak nominal wage growth. Absent an explosion in wage growth, it is hard to describe the labor market as overheated.

The odds that the Fed will hike rates in 2020 went up slightly from last week, but the odds are still higher that there will be one or more rate cuts. The odds that the federal funds rate will be higher by December went up from 3.2% to 5.6%. The odds that the rate will be lower went down from 62.5% to 56.9%. These odds are based on the Fed Funds futures (via the CME FedWatch Tool).

After two weeks of falling yields, Treasury yields mostly increased this week. Only the 30-year yield fell, and that was only a drop of 1 basis point. The 2-year note had the largest yield increase, rising 4 bps to 1.58%. The yield of the 10-year note increased 2 bps to 1.85%. This resulted in a narrowing of the 10-2 spread (the difference between the yields of the 10-year and 2-year Treasury notes.) The spread is now 27 bps, down from 29 bps last week. A negative 10-2 spread has a history of preceding recessions.

The following numbers are based on Daily Treasury Yield Curve Rates and the CME Group FedWatch.

Treasury Yields (Close of 1/13/20):

• 1-month: 1.54% up from 1.52% last week (2.41% a year ago)
• 6-month: 1.57% up from 1.56% last week (2.50% a year ago)
• 1-year: 1.53% same as last week (2.58% a year ago)
• 2--year: 1.58% up from 1.54% last week (2.55% a year ago)
• 5--year: 1.65% up from 1.62% last week (2.52% a year ago)
• 10-year: 1.85% up from 1.83% last week (2.71% a year ago)
• 30-year: 2.30% down from 2.31% last week (3.04% a year ago)

Fed funds futures' probabilities of future rate changes by:

• Jan 2020 - down by at least 25 bps: 0.0% same as last week
• Jan 2020 - up by at least 25 bps: 12.7% up from 9.4% last week
• March 2020 - down by at least 25 bps: 0.0% down from 4.0% last week
• March 2020 - up by at least 25 bps: 16.6% up from 9.0% last week
• June 2020 - down by at least 25 bps: 19.8% down from 26.2% last week
• June 2020 - up by at least 25 bps: 12.8% up from 6.7% last week
• Dec 2020 - down by at least 25 bps: 56.9% down from 62.5% last week
• Dec 2020 - up by at least 25 bps: 5.6% up from 3.2% last week

CD Interest Rate Forecasts

I’m happy to report that more banks and credit unions have been increasing their CD rates. In fact, for the rate leaders, more have increased their rates than lowered their rates in the last week. I think the effect of the Fed’s last rate cut on October 30th is starting to wane on CD rates, and the healthy economy is having more of a positive impact on CD rates.

The following are the noteworthy CD rate changes from last week. Out of the 11 rate changes noted below, six were rate increases. All percentages are APYs.

• Live Oak Bank (5yr fell 15 bps to 2.10%, 3yr fell 10 bps to 2.10%)
• Salem Five Direct (18mo up 10 bps to 2.00%)
• Limelight Bank (18mo up 5 bps to 2.15%, 1yr up 5 bps to 2.10%)
• Comenity Direct (5yr fell 10 bps to 2.10%, 1yr fell 10 bps to 2.00%)
• Greenwood CU (5yr fell 10 bps to 2.50%, 1yr fell 20 bps to 1.80%)
• Affinity Plus FCU (5yr up 25 bps to 3.00%, 18m up 25 bps to 2.25%)
• Mountain America CU (5yr up 5 bps to 2.30%, 1yr up 25 bps to 2.00%)
• Rising Bank (18m Rising up 10 bps to 2.15%, 1yr up 10 bps to 2.15%)
• Popular Direct (5yr up 11 bps to 2.26%)
• Wheelhouse CU (33m fell 20 bps to 2.05%, 22m fell 25 bps to 1.90%)
• Financial Partners CU (5yr Jumbo fell 25 bps to 2.75%)

I will have more rate change details with a focus on the rate leaders in the CD rate summary that will be published this afternoon.

The Fed’s rate cut on October 30th is still having an effect on online savings and money market accounts. The rate leaders have spread out their cuts so it may take another month or two before the rate cuts become rare (assuming the Fed remains in pause mode). Below are examples of important savings and money market rate changes in the last week:

• Vio Bank Direct High Yield Online Savings (-7 bps to 1.95%)
• Comenity Direct High Yield Savings (-10 bps to 1.90%)
• First Internet Bank Money Market Savings (-11 bps to 1.81%)
• CFG Bank High Yield Money Market (-10 bps to 2.15%)

CD rates if the economy remains strong

As I described above, it appears that the Fed will likely be holding rates steady for an extended pause period. The Fed may eventually return to a slow series of rate hikes, but the odds appear low for 2020. In this scenario, we probably won’t see any widespread CD rate increases until after 2020.

If the economy grows above expectations in 2020, that could put upward pressure on CD rates even if the Fed holds rates steady. We saw the opposite of that early last year. During that time, the Fed held rates steady while concerns grew about the economy. Treasury yields were the first to fall. Brokered CD rates were next to fall. By late Spring 2019, direct CD rates started to fall. If we see consistent increases in Treasury yields and brokered CD rates in 2020, that will likely be early signs that direct CD rates will rise, regardless of the federal funds rate changes.

CD rates if the economy weakens

In other scenarios, the economy performs below expectations. That would keep CD rates down for quite some time.

One of these scenarios is an economy that has more of a slowdown than the Fed currently anticipates, but not enough to become a recession. For this scenario, the Fed cuts rates one to three more times, and the extended pause doesn’t begin until sometime in early 2021. The pause would then likely extend through 2021. We would be lucky to see rate hikes in 2022.

The other scenario is the recession scenario. This appears unlikely for now, but it can’t be ruled out. In this scenario, the U.S. economy falls into a recession in the next year, and we return to zero rates. In this scenario, it could take several years before we return to Fed rate hikes.

With rates as low as they are, it wouldn’t take much of a recession for the Fed to return to zero rates. For the period when the Fed held rates near zero (Dec 2008 to Dec 2015), CD rates didn’t fall to zero, but it became difficult to find long-term CDs with rates above 2%.

Occasional 3% CD

As I described in previous Fed summaries, there were times during the zero rate years when a credit union offered 3%+ CDs. PenFed’s 2013 year-end CDs were examples of 3% CDs. Even though 3% CDs are now rare, 3% CD specials will likely pop up every now and then in this current interest rate environment. The latest example is the 3% 5-year CD at Affinity Plus Federal Credit Union.

CD Term Decisions

If it looks like we are headed toward the first scenario, short-term and mid-term CDs would make the most sense. Longer-term CDs make more sense if we’re heading toward more of a slowdown in the economy or a longer pause period.

It’s wise to remember that no one can predict future interest rates. So if you want to keep things simple, a CD ladder of long-term CDs is always a useful strategy for your safe money. If you’re worried about the possibility of rising rates, choose long-term CDs with early withdrawal penalties of no more than six months of interest.

The above graph shows the rate trends of the average CD rates. These average rates are based on all the rate data that we have collected over the years. This is an interactive graph. You can choose the term of the CDs (from 3 months to 5 years) and the look-back period (from 3 months to 5 years).

As you can see in the graph, average CD rates for all terms continue to fall.