As the economy recovers from the pandemic, there is concern that inflation could rise to worrisome levels. However, that worry isn’t shared by the Fed. Fed Chair Jerome Powell downplayed the risks of high inflation after the January FOMC meeting:
We understand the inflation dynamics evolve constantly over time, but they don’t change rapidly. So we think it’s very unlikely that anything we see now would result in troubling inflation.
This week, Fed Chair Powell is giving the Fed’s Semiannual Monetary Policy Report to the Congress. In his opening remarks, Fed Chair Powell continued to downplay the risk of troubling high inflation for the near term:
The economy is a long way from our employment and inflation goals, and it is likely to take some time for substantial further progress to be achieved.
Not everyone is in agreement with the Fed Chair on inflation concerns. Inflation that measures consumer prices (like CPI and PCE) may be low. However, rising inflation can be seen in the recent price increases of assets like stocks, commodities and home values. This Sunday WSJ article described today's situation and the risks to the economy:
Cheap imports from abroad, among other global forces, might be holding down U.S. consumer prices while asset prices march higher, creating new risks that could sideline the economy in unexpected ways.
Asset price bubbles contributed to two of the last three US recessions: a tech stock bubble in the late 90s and a housing price bubble in the late 2000s. So it’s reasonable to think that another asset bubble is in the making now.
One thing that is different today than in the last 20 years is that there is not only massive monetary stimulus from the Fed, but there’s also massive fiscal stimulus from Congress and the President. That increases the risk that troubling high inflation will result. The investor, Michael Burry, who became famous from the movie, “The Big Short”, recently tweeted about this risk:
The US government is inviting inflation with its MMT-tinged policies. Brisk Debt/GDP, M2 increases while retail sales, PMI stage V recovery. Trillions more stimulus & re-opening to boost demand as employee and supply chain costs skyrocket.
A better explanation of what’s happening was provided by investment strategist, Lyn Alden, in her article, “Banks, QE, and Money-Printing:”
In 2008-2014, there was a lot of QE (red line going up), but those dollars didn’t get out into public bank deposits (which is what mostly makes up the broad money supply). This was because there was little or no fiscal transmission mechanism; the government wasn’t sending huge checks to people. [...]
However, 2020 was a very different story. The government sent out tons of money directly into the economy, and financed it by issuing Treasury bonds that the Federal Reserve created new bank reserves to buy.
Lyn Alden admits that high inflation is far from a certainty. In her recent article (Thanks to DA reader NYCDoug who linked to it in the Forum), she described three possible scenarios in an investment flow chart. If fiscal stimulus winds down, deflationary forces will likely dominate which will keep consumer prices down. This will keep the Fed maintaining its current monetary policy with zero rates far into the future. On the other hand, if fiscal stimulus is large enough and lasts long enough, inflation will rise. That could lead to a large increase in long-duration Treasury yields which could force the Fed to adjust its bond buying to lower these yields, in what is known as Yield Curve Control (YCC). That might prevent a stock market crash, but it would increase the odds of much higher inflation. If the Fed doesn’t hold down long-duration yields, the stock market and the financial system will be at risk.
So far in 2021, long-duration Treasury yields have increased substantially, and that has continued in the last week. The 10-year yield started the year at 0.93%. At the start of February, it was up to 1.09%, and as of yesterday, it was up to 1.34%. The 30-year yield rose above 2% on February 12th. At yesterday’s close, it was up to 2.14%. That’s higher than it was one year ago (1.90%) before the pandemic hit the US.
Even the 5-year Treasury yield has increased substantially. At the start of the year, the 5-year yield was 0.36%. At yesterday’s close, it was up to 0.61%. For the last year, online 5-year CDs had a large yield advantage over the 5-year Treasury. However, the advantage has been eroding as online 5-year CD rates have fallen. On February 1st, the average online 5-year CD rate was 0.68%. That’s only 7 bps above yesterday’s 5-year Treasury yield.
On the other side of the yield curve, short-duration Treasury yields have fallen closer to zero. That’s expected since they’re heavily influenced by the federal funds rate. At yesterday’s close, the 3-month yield was 0.03% and the 2-year yield was 0.11%.
The odds of a 2021 Fed rate hike continues to grow according to the CME FedWatch Tool, which lists implied probabilities of future target federal funds rate hikes based on the Fed Funds futures market. The odds are small, but they’re growing. Last week, the odds were 7.9% of at least a 25-bp rate increase by the September and December Fed meetings. Those odds have risen to 13.4%. I suggest not taking these slight odds too seriously. Based on what the Fed has been saying, these slight odds would be more reasonable for 2022 or 2023 even if inflation surges higher this year.
Treasury Yields (Close of 2/22/2021):
- 1-month: 0.03% same as last week (1.60% a year ago)
- 3-month: 0.03% down 1 bp from 0.04% last week (1.56% a year ago)
- 6-month: 0.04% down 1 bp from 0.05% last week (1.53% a year ago)
- 1-year: 0.06% same as last week (1.43% a year ago)
- 2--year: 0.11% same as last week (1.34% a year ago)
- 5--year: 0.61% up 11 bps from 0.50% last week (1.30% a year ago)
- 10-year: 1.37% up 17 bps from 1.20% last week (1.46% a year ago)
- 30-year: 2.19% up 18 bps from 2.01% last week (1.90% a year ago)
Fed funds futures' probabilities of future rate changes by:
- Mar 2021 - up by at least 25 bps: 0.0%, same as last week
- Apr 2021 - up by at least 25 bps: 4.1%, up from 2.0% last week
- Sep 2021 - up by at least 25 bps: 13.4%, up from 7.9% last week
- Dec 2021 - up by at least 25 bps: 13.4%, up from 7.9% last week
CD Interest Rate Forecasts
This was another week in which no major online bank lowered CD rates. That has occurred several times this year, and it may be a sign that online CD rates are near a bottom.
Rate cuts did occur at a few small online banks. The three online divisions of Emigrant Bank (EmigrantDirect, DollarSavingsDirect and MySavingsDirect) all lowered their CD rates. All of their rates now are below the online averages. The highest rate is only 0.45% for CDs with terms from 5 to 10 years.
Northpointe Bank lowered its 5-year CD rate by 5 bps to 0.60%. In late 2018 and early 2019, its 5-year yield had been 3.60%, which was the highest rate for any online bank during this time. Northpointe Bank’s shorter-term CDs haven’t been as competitive, and that continues as its 1-year rate fell 25 bps to only 0.25%.
For credit unions, there’s one small positive change to mention. Michigan State University FCU increased the rates of its 4-year and 5-year CDs. The 5-year Jumbo CD yield increased 10 bps to 1.15%. The shorter-term rates remained unchanged. That’s another sign of some upward pressure on long-term rates.
The other credit unions lowered their CD rates. Wings Financial lowered rates for several CD terms, but it didn’t lower its 5-year rate. Its Jumbo 5-year yield remains at 1.41%, which is near the nationwide rate leaders. Its 4-year Jumbo yield fell 10 bps to 1.11%, and its 1-year Jumbo yield fell 10 bps to 0.70%.
Overall, CD rates are still falling, but the declines have been shrinking in the last few months. That trend continues in February as can be seen in our Online 1-year CD Index which tracks the average rate of 10 well-established online 1-year CDs. The average was 0.46% on February 1st.
The Online 1-year CD Index had its largest drop last March when it fell almost 50 basis points. From April through September, the monthly declines have mostly ranged from 10 to 20 basis points. The monthly declines shrunk to 4 to 5 basis points in October and November. The monthly declines have shrunk to less than 1 basis point in December and January.
As can be seen in our Online 5-year CD Index which tracks the average rate of 10 well-established online 5-year CDs, the decline of 5-year online CD rates has been similar to the 1-year decline except that the early decline was actually steeper. Like the 1-year Index, the monthly declines of the 5-year Index have shrunk in recent months with very little decline in both December and January. On February 1st, the average was 0.68%.
I’m only including one to three CD rate changes per institution to avoid an overload of data. All percentages listed below are APYs.
- Michigan State University FCU (5yr Jbo 1.05% → 1.15%, 4yr Jbo 0.90% → 1.00%)
- Wings Financial CU (4yr 1.21% → 1.11%, 1yr 0.80% → 0.70%)
- American Heritage FCU (5yr 1.05% → 1.00%, 20m 0.92% → 0.80%)
- Credit Union of Denver (4yr 0.90% → 0.80%, 13m Spc 0.90% → 0.80%)
- State Bank of India (3yr SC 0.80% → 0.75%, 1yr SC 0.60% → 0.55%)
- Northpointe Bank (5yr 0.65% → 0.60%, 1yr 0.50% → 0.25%)
- DollarSavingsDirect (5yr 0.50% → 0.45%, 6m 0.40% → 0.35%)
- EmigrantDirect (5yr 0.60% → 0.45%, 16m 0.50% → 0.40%, 6m 0.40% → 0.35%)
- MySavingsDirect (5yr 0.50% → 0.40%, 6m 0.30% → 0.25%)
- WauBank (61m 0.50% → 0.40%, 13m 0.35% → 0.25%)
I was going to say that like CDs, this was another week in which no major online bank lowered their savings or money market rates. I’m afraid I can’t say that. This morning, Synchrony Bank and CIT Bank both lowered their rates. Synchrony lowered its savings and money market rates by 5 bps. Its High Yield savings rate is now 0.50%. CIT Bank also lowered its rates by 5 bps. Its Money Market rate is now 0.45%.
Two weeks ago Discover Bank joined other major online banks like Capital One by lowering its online savings account rate to 0.40%. CIT Bank appears to be heading that way. We’ll see how long Synchrony holds at 0.50%. Other major online banks with savings account rates in the range of 0.50% to 0.60% could decide to join them or at least lower their rates to under 0.50%.
As was the case for CDs, online savings account rate cuts did occur at a few small online banks. The three online divisions of Emigrant Bank (EmigrantDirect, DollarSavingsDirect and MySavingsDirect) all lowered their online savings account rate by 5 bps. The rate at DollarSavingsDirect and EmigrantDirect is now 0.35%. It’s 0.25% at MySavingsDirect. In late 2018 when rates were peaking, MySavingsDirect savings account became a rate leader. In December 2018, it reached a high of 2.40% APY. For the last 16 years, Emigrant Bank’s online divisions have been known for their inconsistent rates. There are times when one of the divisions is a rate leader, but that never lasts. Most of the time, the online divisions lag the online averages.
Online savings account rate declines may be slowing, but the monthly declines are larger than the CD rate declines. This can be seen in our Online Savings Account Index which tracks the average rate of 10 well-established online savings accounts. The Index was dropping 10 to 20 basis points each month from March through September. For the last four months, the monthly declines have shrunk to 2 to 4 basis points. On February 1st, the average online savings account rate was 0.49%.
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.
- Wings Financial CU High Yield Savings (0.70% → 0.60%)
- Quontic Bank High Yield Savings (0.65% → 0.55%)
- Synchrony Bank High Yield Savings (0.55% → 0.50%)
- CIT Bank Money Market (0.50% → 0.45%)
- WauBank High-Yield Savings (0.50% → 0.40%)
- DollarSavingsDirect Savings (0.40% → 0.35%)
- EmigrantDirect Savings (0.40% → 0.35%)
- MySavingsDirect (0.30% → 0.25%)
- State Bank of India Money Market (0.35% → 0.20%)
I’ll have more discussion of the savings and money market rate changes in my liquid account summary later today.
Economic and Deposit Rate Scenarios in 2021
With a new year, it’s time for new scenarios about how the economy and interest rates will evolve over the next year. A rise in interest rates will almost certainly require a steady and strong economic recovery. So future interest rates depend heavily on the future health of the economy.
It’s possible that interest rate increases could be caused by a sustained period of rising inflation. In this case, the Fed may be forced to hike rates even if the economy hasn’t recovered. Based on history, the odds of this happening appear low. However, as I described above, the odds of this appear to be rising. For now, I’ll exclude this scenario.
There’s always the possibility of major shocks to the economy that could cause a depression. A depression would almost surely result in the zero rate environment to continue for at least the next decade. The odds of this are also low.
I think one of the following three scenarios is most likely to occur over the next decade:
- Strong and fast economic recovery
- Slow economic recovery
- No sustained economic recovery
Of course, a quick economic recovery would be the best case scenario for deposit rates, but even in that case, the Fed won’t be in a hurry to raise rates. Their new inflation framework will likely cause them to be slower in their rate hikes than they were in the last zero rate period. In the Fed’s December Summary of Economic Projections, no FOMC participant expects a rate hike in 2021. Only one out of the 17 expects a 25-bp rate hike by the end of 2022. Five expect at least one rate hike by the end of 2023. So in this best case scenario, the Fed will start hiking rates by either the end of 2022 or 2023. As we learned in 2015 and 2016, it can still be a long time from the first Fed rate hike to when we see significant increases in deposit rates. It took about 18 months after the first Fed rate hike in December 2015 before we started to see widespread deposit rate increases.
There are many things that could prevent a strong economic recovery. These include a pandemic that doesn’t go away and government policies that inhibit growth. If economic growth is weak, that will push out the Fed’s first rate hike. In this case, we could see this zero rate period be close in duration to the last one. If it matches the duration exactly, the first Fed rate hike wouldn’t come until March 2027.
Out of the three scenarios, the worst case would result in the Fed holding rates near zero for a period that would be longer than the last one, which lasted seven years. In this scenario, the economy remains weak with high unemployment and low GDP. The economy would have to improve and force inflation to rise in a sustained fashion before the Fed would even think about rate hikes.
Before the Fed starts to hike rates, it’s possible that we’ll see small gains in CD rates. Based on the 2013-2014 history, the start of the Fed tapering its asset purchases could be the first sign of higher CD rates. In May 2013, the Fed Chair started to signal that a pull back or taper of its asset purchases was being considered. The first small pull back was announced by the Fed in December 2013. This period is known as the Taper Tantrum, and Treasury yields did have significant increases in 2013 and 2014. CD rates also had increases.
The Taper Tantrum period of 2013 and 2014 was a time when CD rates went up even as the Fed was holding steady with rates near zero. PenFed’s 5-year CD yield was 1.15% from May to August, 2013 (pre-2020 all-time low). PenFed’s 5-year CD yield increased to 3.04% In December 2013 and January 2014. Ally Bank’s 5-year CD yield increased from 1.51% in May 2013 to 2.00% in September 2014. Synchrony Bank’s 5-year CD yield increased from 1.51% in April 2013 to 2.30% in April 2014, and Discover Bank’s 5-year CD yield increased from 1.50% in October 2013 to 2.10% in August 2014.
Future Rates and CD Term Decisions
It’s possible that we will see a strong economic recovery in 2021 and that will cause the Fed to signal that it’s thinking about tapering its asset purchases. If that happens, we may see some CD rate gains, especially on 5-year CDs, by the end of 2021 or in the first half of 2022. A strong economic recovery also has other effects that contribute to rising deposit rates. A strong economy results in higher loan demand which requires increased deposits. Also, a rising stock market encourages investors to move money from cash into stocks. That lowers deposit levels at banks.These factors encourage banks and credit unions to raise deposit rates.
In the 2013-2014 Taper Tantrum period, 5-year CD rates at online banks increased 50 to 80 basis points. Larger rate increases occurred at a few credit unions. PenFed had some of the largest increases. Its 5-year rate increased almost 200 basis points. If we see similar rate increases in the next two years, we could see top 5-year CD rates at online banks be in a range from 1.50% to close to 2.00%. We could see some CD specials at credit unions with rates above 2.00%.
With at least some possibility of 2% CD specials in 2021 or 2022, locking into long-term CDs with rates near 1% and below doesn’t seem like a good strategy. The possibility of an inflation surge also doesn’t make long-term CDs appealing. If we do start to see 2% CDs in the next two years, it’ll be better to keep cash in online savings accounts or reward checking accounts. Then you’ll be able to jump on those CD specials when they appear. The risk that inflation surges and the Fed is forced to raise rates is another reason to keep your money in liquid accounts.
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 near 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%. There was little to gain with CDs that didn’t have yields higher than this. In today’s new zero rate environment, it appears we are near a bottom for deposit rates. My best guess for this new range for online savings account rates is 0.40% to 0.70%. If you do want to hold CDs, at least make sure that the CD rate is at least higher than 0.70%.
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.
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 2020 to January 2021. The average rates for CDs of all terms are now at 5-year lows. The previous lows occurred more than five years ago in December 2015, just before the Fed’s first rate hike. The average savings account rate (0.154%) is also at a 5-year low. The previous low was 0.177% 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 pandemic 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.