Last week’s release of the September Consumer Price Index (CPI) report showed that inflation is continuing to run hot. CPI for September increased to 5.4% on an annual basis, which was above expectations for a 5.3% increase. Core CPI, which excludes food and energy, increased 4.0% on an annual basis, mostly inline with expectations. These inflation numbers are at 30-year highs, and they reinforce the likelihood that high inflation will persist into 2022.
One component of stagflation is high inflation. Another component is high unemployment. The news last week on retail sales did not point to worsening unemployment. Retail sales in September were above expectations, which is an indication of strong consumer demand. However, that won’t help lower inflation pressures. High consumer demand combined with the ongoing supply chain disruptions are likely to keep upward pressure on inflation.
With high inflation looking less and less transitory, the Fed has started to plan on reversing course. The first step in the long road on returning to more normal interest rates is the start of tapering in which the Fed slows its asset purchases. The minutes of the September Fed meeting were released last week, and according to the WSJ, they “revealed a stronger consensus over scaling back the $120 billion in monthly purchases of Treasury and mortgage securities amid signs that higher inflation and strong demand could call for tighter monetary policy next year.” Under plans that were discussed, the Fed would announce tapering at its November 2-3 meeting, and tapering would begin in Mid-November and be completed by June 2022. Once tapering has ended, the Fed could then turn its attention to rate hikes. The Fed believes that it’s important to end tapering before it hikes rates.
Banking Industry’s Deposit and Loan Levels
If the Fed hikes rates in late 2022, it may still take awhile before banks respond with higher deposit rates. One factor that could cause banks to respond slowly is their deposit and loan levels.
Since the pandemic began, government stimulus checks combined with lower spending has caused America’s personal savings rate to soar which has increased deposit levels at banks to record high levels. Also, loan balances have fallen. That created the perfect storm for deposit rates, resulting in record low deposit rates. It’s clear that some online banks have been trying to shed deposits by slashing their rates to ridiculously low levels.
The latest data on the overall bank deposit and loan balance levels is provided by the Fed’s weekly data of Assets and Liabilities of Commercial Banks.
Fed data released on October 15th showed total deposits of $17,583.2 billion and total loans of $10,469.9 billion. From last week, deposits are up $21.8 billion and loans declined $6.6 billion. From August, deposits are up $148.1 billion and loans are up $43.4 billion.
Deposit growth remains much stronger than loan growth. That trend has to reverse before we see deposit and loan levels return to more normal levels that will encourage higher deposit rates.
In the last week, the 2-year and 5-year Treasury yields had large increases. The 5-year yield was up 8 bps and the 2-year was up 9 bps. Gains didn’t occur on the shorter or longer end of the yield curve. Shorter-term yields had little to no change. The 1-year yield increased just 1 bp while the 3-month and 6-month yields remained unchanged for the week. The 10-year yield had no change in the last week while the 30-year yield actually had a sizable drop, with the yield falling 9 bps.
The rising yields of the 2-year and 5-year Treasury notes were likely driven by rising inflation expectations for the next year or two which may push the Fed to hike rates by the end of 2022. However, those inflation expectations don’t seem to extend long term based on the lack of yield gains on the 10-year and 30-year. The markets appear pessimistic about the long-term health of the economy. Rising rates, high debt levels throughout the economy, and questionable government policies could eventually end rising inflation by taking the economy into recession.
Odds of Fed Rate Hikes
The odds of a Fed rate hike in 2022 and 2023 are up again in the last week after a very large increase from the previous week. This is according to the CME FedWatch tool. The CME FedWatch tool lists implied probabilities of future target federal funds rate hikes based on the Fed Funds futures market. The odds of one or more rate hikes by December 2022 were 91.3% this morning, up from 85.0% last week. The odds of a rate hike by July 2022 are now above 50-50.
Treasury Yields (Close of 10/18/2021):
- 1-month: 0.05% up 2 bps from 0.03% last week (0.09% a year ago)
- 3-month: 0.06% same as last week (0.11% a year ago)
- 6-month: 0.06% same as last week (0.12% a year ago)
- 1-year: 0.11% up 1 bp from 0.10% last week (0.12% a year ago)
- 2--year: 0.44% up 9 bps from 0.35% last week (0.14% a year ago)
- 5--year: 1.16% up 8 bps from 1.08% last week (0.32% a year ago)
- 10-year: 1.59% same as last week (0.76% a year ago)
- 30-year: 2.01% down 9 bps from 2.10% last week (1.52% a year ago)
Fed funds futures' probabilities of future rate changes by:
- Dec 2021 - up by at least 25 bps: 0.0%, same as last week
- Mar 2022 - up by at least 25 bps: 12.3%, up from 2.5% last week
- July 2022 - up by at least 25 bps: 55.8%, up from 46.4% last week
- Dec 2022 - up by at least 25 bps: 91.3%, up from 85.0% last week
- Feb 2023 - up by at least 25 bps: 93.7%, up from 87.5% last week
Deposit Rate Changes and Forecasts
There were just a couple of noteworthy CD rate changes in the last week. This was another week with no CD rate changes from the major online banks.
Two easy-membership credit unions made a few CD rate increases. Most noteworthy were the hikes at Spectra Credit Union. Its CD rates increased 25 bps.
Small gains in CD rates can be seen in the averages. The averages for the online 1-year and 5-year CDs had another month of gains. Both had gains in August and September. These averages are based on the 5-year and 1-year Online CD Indexes which are the average yields of ten online CD accounts from well-established online banks.
The 5-year Online CD Index (5YrOCD) increased 2.50 bps in August and 2.0 bps in September. On August 2, 2021, the 5YrOCD was 0.650%. This increased to 0.695% on October 1, 2021.
The 1-year Online CD Index (1YrOCD) had a smaller two-month gain, rising 0.50 bp in August and 1.50 bps in September. On August 2, 2021, the 1YrOCD was 0.451%. This increased to 0.471% on October 1, 2021.
Both the 5YrOCD and 1YrOCD Indexes are now at their highest yield for 2021, which indicates that we are very likely past the bottom for CD rates.
I’m only including one to three CD rate changes per institution to avoid an overload of data. All percentages listed below are APYs.
- Spectrum CU ($250k+ 5yr 0.75% → 0.80%)
- Spectra CU (5y 0.40% → 0.65%, 1y 0.15% → 0.40%)
I’ll have more discussion of the CD rate changes in my CD summary later today.
Savings, Checking and Money Market Rates
It was a very slow week for liquid account rate changes.
In addition to CD rate increases, Spectra Credit Union also increased the top-tier rate of its money market account. It was a small change, with a rate hike of 5 bps.
For the second straight month, our Online Savings Account Index, which tracks the average rate of ten well-established online savings accounts, had no change. The average remains at 0.446%. Most of the 2021 declines of this average occurred in the first four months of the year. During this time, the average fell from 0.512% to 0.446%. Since the start of May, there has been no net change in the average.
Below are examples of important savings, checking 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.
- Spectra CU Money Market $250k+ (0.30% → 0.35%)
Economic and Deposit Rate Scenarios for 2022 and 2023
Based on the Fed’s September Summary of Economic Projections (SEP), I’ve updated my scenarios about how interest rates will evolve for the next two years. Based on the SEP dot plot which shows the anticipated federal funds rates of each of the 18 FOMC members, I can summarize these into three scenarios of how rates will evolve through 2023. Of course, this assumes that the Fed won’t be way off on their forecasts. As we saw over the last decade, Fed’s forecasts have to be taken with a big grain of salt.
- No Fed rate hikes in 2022, one or two rate hikes in 2023
- One Fed rate hike in 2022, three rate hikes in 2023
- Two Fed rate hikes in 2022, four rate hikes in 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.
One factor that caused the delay was the one year period between the first and second Fed rate hikes. After the first rate hike in December 2015, there were global market and economic problems in early 2016 that caused the Fed to delay further rate hikes until December 2016. Most online savings accounts and short-term CD rates remained flat in 2016. However, many online long-term CD rates fell in 2016.
In 2017, we finally saw the Fed regularly hike rates. The third Fed rate hike occurred in March and the fourth occurred in June. After that third Fed rate hike, we finally saw widespread rate increases on online savings accounts. Those increases were small, but they finally started.
After the fourth Fed rate hike in June 2017, the target federal funds rate range was 1.00%-1.25%. Online savings account rates then started to track the federal funds rate. You can see how the average online savings account rate tracked the federal funds rate in our Online Savings Account Index chart.
The first thing that’s different this time is that deposit rates are much lower than they were in 2015. The major online savings account rates were close to 1%. Today, they’re close to 0.50%. The result of that difference is that it may only take two Fed rate hikes rather than four before we see online savings account rates start inching up.
The second thing that’s different this time is the deposit levels at banks. The government stimulus checks combined with lower leisure spending have contributed to record high deposit levels at banks and credit unions. Most banks don’t need deposits, and thus, they are free to maintain rates at record low levels. Until loan levels rise and deposit levels fall to more normal ranges, banks may not be in a hurry to raise rates after the first few Fed rate hikes.
The third thing that’s different is high inflation that has been rising more than expected. Last December, the Fed had forecasted Core PCE to rise 1.9% in 2022. The September forecast shows Core PCE to rise 2.3% in 2022. This shows that the Fed is starting to worry that the current surge in inflation isn’t entirely transitory. High inflation may force the Fed to act more aggressively than it did in 2016 and 2017, and that may result in deposit rates that move up faster.
Thus, based on history and the current environment, it will likely take two to five Fed rate hikes before we’ll see widespread rate increases to online savings accounts and CDs. There’s no way to know how quickly the Fed will hike rates after liftoff. For the purpose of these scenarios, I’ll assume a range from three to 12 months.
No Fed rate hikes in 2022
In the September SEP, nine of the 18 FOMC members think that there will be no rate hikes in 2022. Only one of those nine think that will continue through 2023. Most of those nine, are forecasting either one or two rate hikes in 2023. In this scenario, the target federal funds rate will be 25 to 50 bps higher than it is today by the end of 2023.
In this scenario, we may start seeing widespread deposit rate increases sometime in 2024.
One Fed rate hike in 2022
Six of the 18 FOMC members anticipate one rate hike in 2022. It can be estimated that those six anticipate three additional rate hikes in 2023. In this scenario, the target federal funds rate will be 100 bps higher than it is today by the end of 2023.
In this scenario, we may start seeing widespread deposit rate increase in the second half of 2023.
Two Fed rate hikes in 2022
The last three of the 18 FOMC members anticipate two rate hikes in 2022. It can be estimated that those three anticipate four additional rate hikes in 2023. In this scenario, the target federal funds rate will be 150 bps higher than it is today by the end of 2023. That would equal the federal funds rate just before the pandemic began in March 2020.
In this scenario, we may start seeing widespread deposit rate increases in the first half of 2023.
Fourth scenario - long period of low rates
In all of the above scenarios, it’s unlikely that we’ll see any widespread deposit rate increases in 2022. There are no signs that the Fed will rush to hike rates. It first has to start the taper process of its asset purchases and complete it sometime in 2022. Then it plans to think about rate hikes. The Fed is prepared for inflation to run over its target, so high inflation is unlikely to force the Fed to hike rates faster than the third scenario that’s described above.
There is a fourth scenario that I’m afraid is not shown by the Fed’s rate forecasts. As we saw in the last decade, the Fed may keep rates lower for a longer period than it anticipates. The pandemic has dragged on longer than many had expected. Also, government policies may be a headwind for the economy. In addition, years of ultra-easy monetary policy have resulted in asset bubbles in the economy. If those bubbles burst and the stock market crashes, the impact to the economy could be another major headwind for the economy.
The fourth scenario is that we don’t see a series of Fed rate hikes through 2024. We may not see any hikes or the Fed may stop after one or two hikes if the economy runs into trouble. This may occur even if inflation runs high. The Fed remains more concerned about high unemployment than high inflation. Stagflation would result, which would be especially difficult for savers who will see their savings lose value as inflation rises.
CD and liquid account decisions
My hopes for CD rate increases in 2021 and 2022 have diminished. There may be an occasional CD special with a rate above 1%, but I would be surprised if we see any nationwide CDs with rates near or above 2%.
CDs with terms of 2+ years are especially unattractive these days, especially when we see the possibility of persistently high inflation. Unfortunately, there are not many better alternatives for your “safe” money. A CD with a 1.35% APY will pay 3x the interest than an average online savings account, assuming rates remain static. There are still a few liquid accounts that have rates at or near 1% without balance limits, but it’s questionable how long their rates will hold. You can also boost your overall yield by using high-yield reward checking accounts. That requires more effort, and there’s risk of rate and balance cap reductions.
Since most CDs don’t provide for much of a rate premium over liquid account alternatives, moving money from matured CDs into liquid accounts may make sense. This is especially the case if you think the Fed will hike rates in 2022. However, as we’ve seen in the past 12 years, rates rarely rise as fast and as high as we expect. The next few years may be different, but you may want to hedge your bets.
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 in 2020. The rates continued to fall in 2021, but at a much slower pace. All rates are at 5-year+ lows. There may be some more slight rate declines, but CD rates should be near or past their bottoms.