After the July Fed meeting, Fed Chair Jerome Powell told reporters that the Fed’s decision to cut rates should be interpreted as a “mid-cycle adjustment” and not a start of a long series of cuts that occurs when there’s a recession or a very severe downturn. Since that day, signs have started to point to a long series of cuts rather than a mid-cycle adjustment. Recession fears appear to be growing as trade tensions increase. Wall Street economists have been coming out with new forecasts for slower growth and rising risks that could lead the Fed to make additional rate cuts.
The market’s fear of a recession may be overblown. As economist Tim Duy stated in his Fed Watch blog post, “we generally lack the data to worry about a recession [...] only industrial production is showing weakness but still less than experienced in the non-recessionary 2015-16 downturn.” If we only see a short-term slowdown in the economy, Fed Chair Powell may have been correct to characterize the Fed action as the start of a “mid-cycle adjustment.” It will take awhile to know which path it will be. If we reach December with the federal funds rate nearing 1% with more talk of rate cuts to come, we’ll know that the Fed’s action was more than just a mid-cycle adjustment.
Falling trade tensions could help reduce the risk of a recession, and a step in that direction occurred today with the U.S. announcement that it would delay some of the tariffs that were scheduled to take effect on September 1st.
An important economic news story occurred today with the Labor Department’s release of the Consumer Price Index for July. The report showed inflation ran slightly above expectations in July with CPI and core CPI rising 0.3% (the consensus was 0.2% for both). This news is unlikely to have much impact on Fed policy. The rising inflation numbers are not high enough to dampen the march toward lower rates.
Another issue that is worrying the markets and economists is the yield curve. Parts of the yield curve have been inverted for awhile, but there is one part that is approaching inversion that has people worried. That part is the 10-2 spread (the difference between the yields of the 10-year and 2-year Treasury notes). A negative 10-2 spread has a history of preceding recessions. Even with months of the 1-month yield remaining above the 10-year yield, the 10-2 spread has remained positive. However, that may not last much longer. At the end of the day Monday, the 10-year yield (1.65%) was only 7 bps above the 2-year yield (1.58%). That spread narrowed quite a bit from last week when it was 16 bps.
The shrinking 10-2 spread is the result of big yield declines in the long-dated maturities. The yield of the 10-year note fell 10 bps from last week while the 2-year yield fell by only 1 bp. The largest drop in yield occurred on the longest-dated maturity, the 30-year bond. Its yield fell 16 bps to 2.14%. The 30-year yield is now only 5 bps above the 1-month yield. With some favorable economic news today, some Treasury yield gains should be expected.
The Fed Funds futures markets (via the CME FedWatch Tool) continue to price in a 100% chance of at least a 25 bp rate cut at the September meeting. The good news is that the odds of larger and additional rate cuts have gone down. The odds of at least a 50 bp cut in September declined from 16.5% last week to 9.6% today. By the end of the year, the odds that the federal funds rate will be at least 50 bps lower than today are now 86.3%, down from 89.4% last week.
Treasury Yields (Close of 8/12/19):
- 1-month: 2.09% up from 2.07% last week (1.92% a year ago)
- 6-month: 1.94% down from 1.99% last week (2.23% a year ago)
- 1-year: 1.75% down from 1.78% last week (2.42% a year ago)
- 2--year: 1.58% down from 1.59% last week (2.61% a year ago)
- 5--year: 1.49% down from 1.55% last week (2.75% a year ago)
- 10-year: 1.65% down from 1.75% last week (2.87% a year ago)
- 30-year: 2.14% down from 2.30% last week (3.03% a year ago)
Fed funds futures' probabilities of future rate CUTS by:
- Sep 2019 - down by at least 25 bps: 100% same as last week
- Sep 2019 - down by at least 50 bps: 9.6% down from 16.5% last week
- Dec 2019 - down by at least 50 bps: 86.3% down from 89.4% last week
- Dec 2019 - down by at least 75 bps: 39.7% down from 46.7% last week
- March 2020 - down by at least 100 bps: 27.6% down from 34.5% last week
CD Interest Rate Forecasts
CD rate cuts have continued in the last week. Most of the cuts came after the July Fed meeting as the new month started.
In the last week, we have seen several more banks and credit unions cut their CD rates, and we have seen several that have added on to previous rate cuts. Recent examples of institutions that have cut rates include:
- Popular Direct (5yr fell 15 bps to 2.55% APY, 1yr fell 5 bps to 2.25% APY)
- Vio Bank (5yr fell 15 bps to 2.00% APY, 1yr fell 15 bps to 1.75% APY)
- American Express National Bank (5yr fell 15 bps to 2.55% APY, 18mo fell 35 bps to 2.15% APY)
- Live Oak Bank (4yr fell 10 bps to 2.60% APY, 2yr fell 10 bps to 2.60% APY)
- First National Bank of America (5yr fell 5 bps to 2.85% APY, 1yr fell 10 bps to 2.50% APY)
- Georgia Banking Company (5yr fell 20 bps to 2.75% APY, 1yr fell 25 bps to 2.25% APY)
I’ll have more listings of rate cuts in my CD summary that will be published later today.
If you do think that we are experiencing just a mid-cycle adjustment at the Fed, it may not be wise to load up on long-term CDs. However, even if the Fed isn’t at the start of a long series of rate cuts, I can’t see the federal funds rate returning to where it was before July anytime soon. The process of returning to early-2019 federal funds rate would probably take at least two years.
First, there will probably be at least two more 25-bp rate cuts even if the slowdown and risks are short-lived. Before the Fed would return to a pause period, it would have to be clear that the risks had significantly diminished and that the economy had improved considerably. Then the Fed would return to a pause period where it waits to ensure that the falling risks and the improving economy were able to hold. That pause period would likely be at least six or more months. Then the Fed would start talking about rate hikes. After a couple of Fed meetings, we may finally see a return to rate hikes. Then it may take another year before rates return to where they were in the first half of this year. As you can see, it could take at least a couple of years before we see deposit rates at the level that we saw in the second half of 2018, and that assumes that we’re experiencing only a small economic slowdown.
Since it’s unlikely that we’ll see widespread rate hikes in the next couple of years (even if the economy stays strong), I think it makes sense to allocate more of your savings into mid-term and long-term CDs rather than savings accounts and short-term CDs.
There are still a few 3% CDs that are nationally available at both banks and credit unions. I think 3% CDs will be essentially gone by the fall. A 3% CD special may pop up now and then (like what Navy Federal began offering), but I’m afraid those specials will probably become rare.
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 are not rising like they were in 2018 and early 2019. Most of the averages are now starting to decline.
Note: This Fed and economic overview used to be part of my weekly summary, but it will now be a separate post. My weekly summaries will now be focused entirely on deposit rates and deals, and they will be published on Tuesday evenings.