Federal Reserve, the Economy and CD Rate Forecast - Oct 15, 2019

The recent progress on the trade talks has slightly reduced the odds that the Fed will cut rates again at its October 29-30 meeting. However, the Fed may determine that one more rate cut would be wise based on the risks to the economy that have grown since their last meeting.

The minutes of the last Fed meeting were released last Wednesday, and they showed that the Fed’s concern about the economy has grown since their July meeting:

Participants generally had become more concerned about risks associated with trade tensions and adverse developments in the geopolitical and global economic spheres. In addition, inflation pressures continued to be muted.

The effects of the trade tensions and global developments have been impacting business investment, and the Fed is seeing higher risks for a larger slowdown in the economy:

softness in business investment and manufacturing so far this year was seen as pointing to the possibility of a more substantial slowing in economic growth than the staff projected.

The weaker-than-expected reading in the ISM’s manufacturing sector that came out on October 3rd will keep the Fed worrying about the risks of a manufacturing-driven slowdown.

Also, the CPI report last week showed muted inflation. Core CPI was only 0.1%. That will also make it easier for the Fed to justify a rate cut.

Thanks to a strong September jobs report with the unemployment rate reaching a 50-year low of 3.5%, a Fed rate cut this month is far from a sure thing, and if the good news on the trade talks continues, there’s a decent chance the Fed may decide to hold steady on rates.

The odds of an October Fed rate cut did go down quite a bit from last week, according to the Fed Funds futures markets (via the CME FedWatch Tool). The odds of a 25 bp rate cut at the October meeting fell from 83.9% to 74.3%. The odds that the federal funds rate will be at least 50 bps lower by December is now 24.1%, which is down substantially from 42.1% last week.

Most Treasury yields ended Friday higher than they were on Tuesday (my last Fed review). The 5-year note had the largest yield gain, rising 23 bps to 1.59%. The 10-year yield gain of 22 bps was close behind as was the 2-year yield gain of 21 bps. This resulted in a slight widening of the 10-2 spread (the difference between the yields of the 10-year and 2-year Treasury notes.) The spread is now 13 bps, up from 12 bps last week. A negative 10-2 spread has a history of preceding recessions.

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

Treasury Yields (Close of 10/11/19):

• 1-month: 1.76% up from 1.69% last week (2.14% a year ago)
• 6-month: 1.68% down from 1.69% last week (2.44% a year ago)
• 1-year: 1.67% up from 1.62% last week (2.66% a year ago)
• 2--year: 1.63% up from 1.42% last week (2.85% a year ago)
• 5--year: 1.59% up from 1.36% last week (3.00% a year ago)
• 10-year: 1.76% up from 1.54% last week (3.15% a year ago)
• 30-year: 2.22% up from 2.04% last week (3.32% a year ago)

Fed funds futures' probabilities of future rate CUTS by:

• Oct 2019 - down by at least 25 bps: 74.3% down from 83.9% last week
• Dec 2019 - down by at least 25 bps: 82.6% down from 92.0% last week
• Dec 2019 - down by at least 50 bps: 24.1% down from 42.1% last week
• March 2020 - down by at least 75 bps: 11.2% down from 29.7% last week

CD Interest Rate Forecasts

CD rate cuts continue to be common at both banks and credit unions. With the odds of another Fed rate cut in October still high, I expect CD rate cuts to continue.

Below are a few recent examples of CD rate cuts from last week. These focus on the popular institutions and former rate leaders. All percentages are APYs.

• Ally Bank (5yr fell 10 bps to 2.30%, 1yr fell 10 bps to 2.15%, 11mo fell 5 bps to 2.00%)
• Capital One (1yr 360 CD fell 10 bps to 2.20%)
• PenFed (5yr fell 10 bps to 1.85%, 1yr fell 10 bps to 1.70%)
• Comenity Direct (5yr fell 5 bps to 2.45%, 1yr fell 5 bps to 2.25%)
• First National Bank of America (5yr fell 15 bps to 2.55%, 1yr fell 10 bps to 2.35%)
• BrioDirect (1yr fell 15 bps to 2.25%)
• Quontic Bank (5yr fell 15 bps to 2.25%, 1yr fell 15 bps to 2.25%)
• WebBank (5yr fell 25 bps to 2.05%, 1yr fell 10 bps to 2.05%)
• State Farm Bank (5yr fell 15 bps to 2.25%, 30mo fell 15 bps to 2.10%)

The recession scenario is still quite possible. In this scenario, the U.S. economy falls into a recession in the next year, and we return to zero rates. With rates as low as they are, it wouldn’t take much of a recession for the Fed to return to zero rates. For the period when the Fed held rates near zero, CD rates didn’t fall to zero, but it became difficult to find long-term CDs with rates above 2%.

The history of Ally Bank’s 5-year CD rate offers an example of how long-term CD rates responded to the last period of zero rates, Ally Bank’s 5-year CD fell to a bottom APY of 1.50% in 2013. The 5-year APY remained below 2.00% from November 2012 until September 2014 when it reached 2.00% APY. It didn’t rise above 2.00% until April 2017, which was just after the Fed’s third rate hike during its rate hiking cycle.

Based on last month’s Fed meeting and their dot plot, the recession scenario doesn’t appear to be the most likely one. Based on the Fed’s projections, the most likely scenario is one more rate cut followed by a slow return to rising rates. Nine out of the 17 Fed members anticipate that rates will be back to early-2019 levels between 2021 and 2022. If that does occur, CD rates should start rebounding next year.

A third scenario based on recent economic news is an economy that has more of a slowdown than the Fed anticipates, but not enough to become a recession. In that case we may not return to zero rates, but we could see three or four more Fed rate cuts. If that happens, we would probably not see the Fed returning to rate hikes until 2021 at the earliest, and it would then probably take another year for a return to CD rates that we saw in late 2018.

Since it’s unlikely that we’ll see widespread rate hikes in the next year (even if this rate cutting cycle is short), 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. If you’re optimistic about the economy, choose mid-term CDs. If you’re less optimistic, choose long-term CDs.

Another thing to consider is what CD rate you are able to obtain. As more and more CD rates fall, it will become difficult to find not only a 3% APY, but even a 2.50% APY. For example, only two banks (not credit unions) currently offer nationally available 5-year CDs with rates above 2.60%. As CD rates fall, the benefit of locking into long-term CDs diminishes, and that’s especially the case if the economy is not headed toward recession.

There continues to be a few credit unions that are still offering 3% CDs, but those credit unions have become rare. Navy Federal’s 5-year CD continues to be one of the few which still offer a 3% APY. There are no longer any banks that I’m aware of that are offering nationally available CDs with yields of at least 3%. Note, to see Navy Federal’s CDs in the CD rate table, click on “Advanced options” in the filter box and click on “Select All”. This will include credit unions in the table that primarily limit membership to select employer groups.

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 now on the 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.