Federal Reserve, the Economy and CD Rate Forecast - May 26, 2020

Two weeks from now the next two-day FOMC meeting is scheduled to start. This will be the first meeting this year that should include an update to the Summary of Economic Projections (SEP). This had been planned for the March meeting, but after two emergency meetings, the Fed decided to skip the SEP update since the pandemic had caused too many future uncertainties for the SEP to be useful.

If the SEP update is provided at the June meeting, it should be very interesting. It will show the FOMC member projections on the important economic numbers. More interesting for savers will be the federal funds rate projections. Of course, these projections become meaningless when there are unexpected shocks to the economy. In the December SEP, no FOMC member forecasted the federal funds rate to drop in 2020. Even though you have to take the projections with a grain of salt, they will provide insights into the Fed’s expectations on the economic recovery and when a Fed rate hike might be a possibility. We’ll see if any FOMC member is forecasting rate hikes in 2021, 2022 and 2023.

Based on recent interviews and speeches by Fed Chair Jerome Powell, I wouldn’t be surprised if all the FOMC members anticipate the federal funds remaining at the zero bound through 2022. Fed Chair Powell’s testimony last week to the Senate Committee on Banking, Housing, and Urban Affairs included some dire views of the economy such as this one:

Available economic data for the current quarter show a sharp drop in output and an equally sharp rise in unemployment. By these measures and many others, the scope and speed of this downturn are without modern precedent and are significantly worse than any recession since World War II.

It’s too early to know if the Fed’s current zero interest rate policy (ZIRP) will last longer than the period after the 2008 financial crisis. That lasted for seven years from December 2008 to December 2015. The second half of 2020 will be important. If we don’t start to see a strong recovery during this time, the odds of an extended ZIRP period increases.

Soon after the Fed cut rates to the zero bound on March 15th, the CME FedWatch Tool showed zero odds that the target federal funds rate was going to change at all future Fed meetings up through March 2021. It showed 100% odds that there would be no rate changes. At first I thought we may start seeing small odds for negative rates, but due to this “zero bound” assumption used by CME, the CME FedWatch Tool still shows no chance of negative rates in the future. Two weeks ago, there were media reports that the Fed Funds futures market was pricing in negative rates for next year. This may cause a change in the CME FedWatch Tool to accommodate negative rates, but so far, this hasn’t been done.

I had assumed that the 100% odds of no change would continue until the CME FedWatch Tool is changed to handle negative rates. However, three weeks ago, we started to see slight odds of a 25bp rate hike. Those odds went down this week. The odds are now under 1% for any rate hike through March 2021.

Even tiny odds of a rate hike this year don’t seem right. I wonder if this might be an artifact of the Tool not being able to handle negative rates. It sure seems that negative rates are more likely than the Fed deciding to hike rates this year. The Fed has made it clear that it plans to wait “until it is confident that the economy has weathered recent events” before deciding to hike rates. It’s possible that the markets are seeing at least a tiny possibility of rising inflation and/or a very strong economic recovery. Even in that scenario, I can’t see any odds of a rate hike in 2020.

Most Treasury yields changed little from last week. The 10-year note had the largest yield change, falling 4 bps to 0.69%.

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

Treasury Yields (Close of 5/26/20):

• 1-month: 0.10% same as last week (2.37% a year ago)
• 3-month: 0.14% up 1 bp from 0.13% last week (2.35% a year ago)
• 6-month: 0.17% up 2 bps from 0.15% last week (2.39% a year ago)
• 1-year: 0.17% same as last week (2.33% a year ago)
• 2--year: 0.18% same as last week (2.16% a year ago)
• 5--year: 0.35% down 3 bps from 0.38% last week (2.12% a year ago)
• 10-year: 0.69% down 4 bps from 0.73% last week (2.32% a year ago)
• 30-year: 1.43% down 1 bp from 1.44% last week (2.75% a year ago)

Fed funds futures' probabilities of future rate changes by:

• June 2020 - up by at least 25 bps: 0.7% down from 6.4% last week
• Sep 2020 - up by at least 25 bps: 0.7% down from 6.2% last week
• Dec 2020 - up by at least 25 bps: 0.7% down from 5.7% last week
• Mar 2021 - up by at least 25 bps: 0.6% down from 5.5% last week

CD Interest Rate Forecasts

This has been another busy week for CD rate cuts. In March and April, most online banks had been slowly transitioning to lower rates. That changed in May. After a few of the major online banks slashed rates, the other online banks quickly followed, creating an avalanche of cuts.

A small group of rate changes are cuts from banks and credit unions that continue to offer rates above 1.50%. This includes Pen Air Federal Credit Union which lowered its 5-year rate to 1.85% APY. This is the latest institution to lower their 5-year rate below 2.00%.

Unfortunately, the largest group are rate changes from banks and credit unions that lowered CD rates in the range of 1.20% to 1.50%. This group includes major online banks like Ally, Capital One and Synchrony. The group also includes small banks that had been rate leaders, including The Federal Savings Bank and Comenity Direct.

The most disappointing group includes those that have lowered their rates below 1.00%. Andrews Federal Credit Union is in this group. Its CD rates used to be rate leaders. In early March, its 7-year CD had a 3.05% APY. Now, the 7-year CD and all the other CDs have rates that are pathetically low. In the last two weeks, the 7-year CD rate fell from 1.20% to 0.30%, and the 5-year fell from 1.15% to 0.20%.

Once a CD rate falls below 1.00%, I can’t see any benefit over an online savings account. Based on the 2008-2015 zero interest rate period, online savings accounts were always available with rates in the range of 0.70% to 1.00%. If that continues, there’s no benefit of a sub-1.00% CD.

Since there were so many rate cuts in the last week, I’m only listing rate cuts that are most interesting for DA readers. Also, I’m only including one to three CD rate changes per institution to avoid an overload of data. All percentages listed below are APYs.

• Pen Air FCU (5yr 2.00% → 1.85%, 18m 1.60% → 1.55%)
• Hiway FCU (5yr 1.75% → 1.60%)
• First Internet Bank (5yr 1.67% → 1.57%, 1yr 1.31% → 1.29%)
• WauBank (61m 1.65% → 1.45%, 13m 1.55% → 1.35%)
• Comenity Direct (5yr 1.65% → 1.45%, 1yr 1.55% → 1.35%)
• Ally Bank (5yr 1.50% → 1.40%, 1yr 1.35% → 1.30%, 11m NP 1.30% → 1.25%)
• Synchrony Bank (5yr 1.50% → 1.40%, 1yr 1.35% → 1.00%)
• The Federal Savings Bank (5yr Promo 2.05% → 5yr Jumbo 1.40%)
• First National Bank of America (5yr 1.55% → 1.40%, 1yr 1.15% → 1.05%)
• Capital One (5yr 1.40% → 1.30%, 1yr 1.30% → 1.00%)
• CIT Bank (5yr 1.40% → 1.30%, 1yr 1.35% → 1.30%, 11m NP 1.30% → 1.20%)
• Alliant CU (5yr 1.40% → 1.25%, 1yr 1.30% → 1.20%)
• Popular Direct (5yr 1.30% → 1.20%, 1yr 0.50% → 0.45%)
• Rising Bank (18m Rising 1.30% → 1.20%, 1yr 1.45% → 1.30%)
• Andrews FCU (7yr 1.20% → 0.30%, 5yr 1.10% → 0.20%, 1yr 0.50% → 0.05%)

In early May, several major online banks slashed their savings account rates by 20 to 25 bps. There were a few large rate cuts this week. These include HSBC Direct (30 bps cut), Western State Bank (25 bps cut), and WebBank (20 bps cut). Most of the cuts were in the 10 to 15 bps range. Unfortunately, the number of rates above 1.50% are diminishing.

During the zero bound years from 2008 to 2015, most online savings account rates bottomed out in a range from 0.70% to 1.00%. I’m hoping that we won’t see new bottoms from the major online banks. However, based on how their CD rates are falling, I am a little worried.

Below are examples of important savings and money market rate changes in the last week. As is the case with the CD rates, I’ve included only rate changes from the online savings accounts that DA readers would be most interested in. All percentages listed below are APYs.

• First Foundation Bank Online Savings (1.75% → 1.60%)
• UFB Direct High Yield Savings (1.61% → 1.51%)
• BMO Harris Bank Platinum MM (1.65% → 1.50%)
• Comenity Direct High-Yield Savings (1.55% → 1.45%)
• All America/Redneck Bank Mega MMA (1.50% → 1.35%)
• Western State Bank High Yield MM (1.60% → 1.35%)
• Popular Direct Ultimate Savings (1.50% → 1.35%)
• Rising Bank High Yield Savings (1.40% → 1.30%)
• HSBC Direct Savings (1.60% → 1.30%)
• WauBank High-Yield Savings (1.50% → 1.30%)
• CIT Bank Money Market (1.40% → 1.30%)
• CIT Bank Savings Builder (1.30% → 1.25%)
• BrioDirect High-Yield Savings (1.40% → 1.25%)
• Discover Online Savings (1.25% → 1.15%)
• WebBank Savings (1.31% → 1.11%)

I’ll have more discussion of the savings and money market rate changes later tonight in my liquid account rate summary.

Scenario #1: Pandemic wanes and the economy surges back

I’m still keeping this as a possibility. It’s possible that the COVID-19 pandemic turns out to be less of a shock to the economy than current expectations. If that occurs, the U.S. avoids a major recession, and the economy surprises on the upside later this year.

Even if this best-case economic scenario takes place, it seems unlikely rates will rebound quickly. The Fed moved quickly to the zero bound, and it appears prepared to keep it there for many months after the economy recovers. It’s possible that rising inflation could force the Fed to hike rates, but recent history on inflation doesn’t support that. My guess for this best-case scenario is that the Fed goes back to rate hikes in 2023, which is my same prediction from last week.

Scenario #2: Economy falls into a major recession and CD rates remain low for years

The shutdowns are starting to end in many states, and that lowers the odds of this scenario in which the pandemic causes a prolonged and severe recession. However, we are still a long way off from a widespread and full reopening of the economy. Any major resurgence of COVID-19 could derail the recovery.

There’s also the possibility that the pandemic will burst the debt bubble, causing an economic meltdown with a wave of business closures and panic in the financial markets. The Fed has so far been able to keep the financial markets running, and I don’t see a significant risk of an economic meltdown happening in the near term.

If a major recession does occur, the Fed will likely follow a path similar to the one it took after the 2008/2009 recession. It may not take seven years of the zero bound before we see the next Fed rate hike, but in this #2 scenario, it will likely take at least five years for the U.S. economy to recover to the point in which the Fed will start hiking again.

Future Rates and CD Term Decisions

Now that the Fed has returned rates to the zero bound, we can look to the last zero bound years from 2008 to 2015 to help predict what we’ll see in deposit rates. During those years, it did become difficult to find long-term CD rates over 2%, but there were a few rare times when 3% CDs became available. PenFed’s 2013 CDs are an example. I doubt we’ll see any 3% CDs for a while, but that could change in 2021 even if the Fed remains at the zero bound. This would require scenario #1 to occur.

Long-term CDs are making more sense as we appear to be headed back into a long period of very low rates. However, long-term CD rates are no longer attractive. It’s now difficult to find 2% CDs. In fact, many long-term CD rates from the online banks are now under 1.50%. Does a 5-year CD at 1.50% make sense today? It’s hard to say yes to that when there are still many online savings accounts with rates equal to or a little above 1.50%. However, one or two years from now, you may regret keeping too much in a savings account if all savings account rates soon fall below 1.00%.

During the zero bound days from 2008 to 2015, online savings account rates remained in a range of 0.70% to 1.00%. Thus, there was little to gain with CDs that didn’t have yields higher than this. I can’t say for sure if online savings account rates will remain in this range this time. Over the last 20 years, each recession appears to bring with it ever lower deposit rates.

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.

Another option for your CD ladder is a ladder of short-term CDs, such as those with 1-year terms. Since many 5-year CDs have equal or lower yields than 1-year CDs, the 5-year CD ladders don’t offer much advantage. Of course, 1-year CD ladders don’t offer the rate lock which may be beneficial if rates keep falling.

CD Rate Trends

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 plunged in March and April. The longer-term CDs had the largest rate reduction. The average 5-year CD rate is now below the average rate five years ago before the first Fed rate hike of the last tightening cycle.

Safety of the Banking System and Your Deposits

Even though the banking industry is in a much better position now than it was in 2008, the crisis is stressing the financial system. Weak banks and credit unions will have a higher chance of failing over the next year. Thus, this is the time to be extra careful that your deposits are within the FDIC and NCUA limits.