Federal Reserve, the Economy and CD Rate Forecast - August 4, 2020

Last week’s FOMC meeting and press conference by Fed Chair Powell further reinforced the long road ahead of near-zero rates. Fed Chair Powell explained that even after the pandemic is over, it could take years for the unemployment rate to fall back to the pre-pandemic rate. Even when that does occur, the Fed will be in no rush to hike rates. More reports have come out that point to the Fed being willing to accept inflation running above its target for a while before deciding to hike rates. According to this WSJ article:

The Federal Reserve is preparing to effectively abandon its strategy of pre-emptively lifting interest rates to head off higher inflation, a practice it has followed for more than three decades.

Although an economic recovery may not result in rate hikes in the next year or two, an economic recovery is the first step toward higher rates. One small sign of the recovery came last week in the second quarter GDP. It fell by an annualized rate of 32.9%. This was a record-breaking decline, but it was better than the expectations of economists who had predicted a fall of 34.7%. The July jobs report is scheduled for release this Friday, and according to Calculated Risk, the "consensus is for 1.36 million jobs added, and for the unemployment rate to decrease to 10.7%.” The recent surge in COVID-19 cases in some states may cause the unemployment rate not to fall as expected. It’s unlikely that we’ll see a strong recovery until there is a lot more progress in dealing with the virus.

For about a month before the June 10th Fed meeting, the Fed Funds futures market (via the CME FedWatch Tool) was showing slight odds of a rate hike through March 2021. Once the June 10th Fed meeting took place with the new economic projections that showed no expectations for rate hikes through 2022, the Fed Funds futures have shown zero odds of any rate hikes through March 2021. That continues this week.

Due to a “zero bound” assumption used by CME, the CME FedWatch Tool still shows no chance of negative rates in the future.

All Treasury yields fell from last week with the 5-year and 10-year yields falling the most. The 5-year fell 8 bps to 0.22%, and the 10-year fell 6 bps to 0.56%.

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

Treasury Yields (Close of 8/3/20):

• 1-month: 0.09% down 1 bp from 0.10% last week (2.11% a year ago)
• 3-month: 0.10% down 1 bp from 0.11% last week (2.06% a year ago)
• 6-month: 0.11% down 3 bps from 0.14% last week (2.02% a year ago)
• 1-year: 0.12% down 2 bps from 0.14% last week (1.85% a year ago)
• 2--year: 0.11% down 4 bps from 0.15% last week (1.72% a year ago)
• 5--year: 0.22% down 8 bps from 0.30% last week (1.66% a year ago)
• 10-year: 0.56% down 6 bps from 0.62% last week (1.86% a year ago)
• 30-year: 1.23% down 2 bps from 1.25% last week (2.39% a year ago)

Fed funds futures' probabilities of future rate changes by:

• Sep 2020 - up by at least 25 bps: 0.0% same as last week
• Dec 2020 - up by at least 25 bps: 0.0% same as last week
• Mar 2021 - up by at least 25 bps: 0.0% same as last week

CD Interest Rate Forecasts

The start of the month has brought a surge of CD rate cuts, but the surge isn’t as big as I had feared. Banks and credit unions are generally making two types of cuts.

First are those that continue to make small rate cuts. For credit unions these include Navy Federal and PenFed. Navy Federal’s 5-year CD rate for a $100k minimum just fell 5 bps to 1.25% APY. PenFed’s 5-year CD rate fell 10 bps to 0.90% APY.

There are also banks that are making small cuts. State Bank of India and TIAA Bank are in this group. Last week, State Bank of India’s 5-year Senior Citizens CD rate fell 10 bps to 1.21% APY. TIAA Bank’s 2-year Yield Pledge CD rate fell 5 bps to 1.00% APY.

The second group are credit unions and banks that are making large CD rate cuts. Two examples are Western Vista FCU and Interior FCU. In the last few months, both had CD rates that were high enough to be in my bi-weekly CD summary. Their rates had been falling in previous months, but in the last week, both had big rate cuts. Western Vista FCU’s 5-year CD rate fell 33 bps to 0.96%. Interior FCU had a 5-year Jumbo CD APY of 2.52% in March. Last week the 5-year Jumbo CD yield fell from 1.31% to 0.80%.

Online banks are also in this second group. Three examples include Barcalys, CIT Bank and BrioDirect. Not only did they have big cuts on their CD rates last week, but they also have new CD rates that are disturbingly low. Barclays’ 5-year CD rate fell to 0.65%. CIT’s 1-year CD rate fell to 0.50%, and BrioDirect’s 5-year CD rate fell to 0.45%. BrioDirect had a top 5-month CD rate in the last couple of months, but that also had a big rate cut, with the yield falling from 1.15% to 0.65%.

I’m worried that these big cuts are suggesting a low bottom for CD rates that will be much worse than what we experienced during the last zero rate period from 2008 to 2015. For example, the online bank Barclays was launched in early 2012. Before this year, its 5-year CD had an all-time low of 1.65% APY in 2013. It took less than five months of this new zero rate period for a new all-time low that’s an entire percentage point lower.

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 two to three CD rate changes per institution to avoid an overload of data. All percentages listed below are APYs.

• Navy FCU (5yr 1.30% → 1.25%, 1yr 1.10% → 0.95%)
• State Bank of India (5yr SC 1.31% → 1.21%, 1yr SC 1.21% → 0.91%)
• Mountain America CU (5yr 1.35% → 1.10%, 1yr 0.55% → 0.40%)
• Signature FCU (5yr Jumbo 1.30% → 1.10%, 1yr Jumbo 1.20% → 1.00%)
• Pacific National Bank (15m Online 1.10% → 1.05%, 1yr Online 1.05% → 1.00%)
• USALLIANCE Financial CU (18m Spc 1.10% → 1.02%, 12m Spc 1.05% → 1.00%)
• TIAA Bank (2yr YP 1.05% → 1.00%, 18m YP 1.01% → 0.98%)
• Western Vista FCU (5yr 1.29% → 0.96%, 1yr 0.47% → 0.35%)
• PenFed CU (5yr 1.00% → 0.90%, 1yr 0.70% → 0.50%)
• Interior FCU (5yr Jumbo 1.31% → 0.80%, 1yr Jumbo 1.06% → 0.50%)
• Barclays (5yr 0.85% → 0.65%, 1yr 0.85% → 0.65%)
• CIT Bank (18m 0.75% → 0.50%, 1yr 0.75% → 0.50%, 11m NP 0.75% → 0.50%)
• BrioDirect (5yr 1.00% → 0.45%, 1yr 1.00% → 0.45%, 5m 1.15% → 0.65%)

Like CD rates, online savings and money market account rates continue to fall toward 1% and under. In the last week, ten fell below 1%. Only three that had rate cuts remain above 1%, and those three are just barely above 1%.

Four of the major online banks slashed their online savings account rates to well below 1% in the last week. Synchrony Bank slashed its rate 30 bps to 0.75%. Marcus by Goldman Sachs slashed its rate 25 bps to 0.80%. Both Capital One and Barclays slashed their rates 20 bps to 0.80%. This is a new all-time low at Barclays. Before this year, the lowest online savings account rate at Barclays was 0.90% in 2013 and 2014.

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.

• Nationwide by Axos Bank My Savings (1.15% → 1.05%)
• Citi Accelerate Savings (1.10% → 1.05%)
• Vio Bank Online Savings (1.11% → 1.04%)
• Nationwide by Axos Bank Money Market Plus (1.00% → 0.90%)
• Axos Bank High Yield Savings (1.10% → 0.90%)
• ableBanking Money Market Savings (1.05% → 0.90%)
• PenFed CU Premium Online Savings (1.00% → 0.90%)
• Marcus by Goldman Sachs AARP Savings (1.15% → 0.90%)
• Amboy Direct Personal Savings (1.05% → 0.85%)
• DollarSavingsDirect Savings (1.00% → 0.85%)
• Capital One 360 Performance Savings (1.00% → 0.80%)
• Barclays Online Savings (1.00% → 0.80%)
• State Bank of India Money Market Deposit (0.95% → 0.80%)
• Marcus by Goldman Sachs Savings (1.05% → 0.80%)
• Synchrony Bank High Yield Savings (1.05% → 0.75%)

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

Scenario #1: Pandemic wanes and the economy surges back

The latest Fed forecasts and the recent resurgence of COVID-19 cases have lowered the odds that the economy surges back. Nevertheless, this scenario of the economy recovering quickly as the pandemic subsides (either on its own or due to vaccines and new treatments) is still a possibility. If that occurs, the U.S. avoids a major recession, and the economy surprises on the upside later this year.

Once the economy has reached full recovery, we’ll then have to wait on the Fed to feel confident about the recovery before it starts hiking rates. This could take a year or more as it did in 2015 to 2017. It’s possible that rising inflation could force the Fed to hike rates, but inflation history and recent inflation data don’t support that possibility. I’m going to maintain my best-case date of 2023 for when the Fed goes back to rate hikes. This is probably overly optimistic, but I’m going to keep it for now.

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

As we are seeing, the COVID-19 pandemic may not end anytime soon. The longer the pandemic impacts businesses, the more business closures and permanent layoffs will result. That could lead to a long-term recession.

There’s also the possibility that the pandemic or another shock 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 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. If inflation stays stubbornly low, it may take longer than seven years.

Future Rates and CD Term Decisions

Now that the Fed has returned rates to the zero bound, we can look to the zero-bound years from 2008 to 2015 to help predict what we’ll see in deposit rates. However, as I described above, we are seeing signs that this zero-bound period will be worse for deposit rates. Nevertheless, the history of the last zero-bound years may be useful.

During the last zero-bound period from 2008 to 2015, 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. In fact, it looks like 2% CDs will probably be non-existent for the remainder of this year. Now, it even looks like 1% CDs may soon become rare.

These sub 2% and sub 1% CDs could change in 2021 if a strong recovery does take place even if the Fed remains at the zero bound. If scenario #1 occurs and we see a strong economic recovery, banks and credit unions will likely see a surge of loan demand which will require deposits. That will lead to higher CD rates and more CD specials even as the Fed holds rates at zero. A rising stock market also helps this process as investors move their money from cash to stocks.

With at least some possibility of 3% CD specials (or 2%) in 2021, locking into long-term CDs with rates near 1% doesn’t seem like a good strategy. If we do start to see 3% CDs (or 2%) in 2021, it’ll be better to keep cash in online savings accounts or no-penalty CDs. Then you’ll be able to jump on those CD specials when they appear.

Long-term CDs now only make sense if we’re headed back into a long period of very low rates. In that case a 1% long-term CD will be better than a top savings account with a rate under 0.50%.

During the zero-bound years 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. As I mentioned above, today’s online savings account rates are already nearing the low end of this range.

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 being locked into a low-rate CD if rates start rising, 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 from March through July. The average rates for CDs with terms over two years are now at 5-year lows. The previous lows occurred five years ago in August 2015. Shorter-term CD rates are still a little above the lows from five years ago. The average savings account rate (0.177%) is now tied with its previous low that occurred in December 2016.

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.

Post Publication Edits

8/5/2020: Rewording of sentence discussing worry of rising rates.