The most significant outcome from last week’s FOMC meeting was the dot plot changes in the Summary of Economic Projections (SEP). Several more FOMC participants have pulled in their forecasts regarding when the target federal funds rate will be increased. In the March SEP, only 7 of the 18 participants forecasted at least one rate hike by the end of 2023. Last week’s SEP shows that 13 of the 18 participants now forecast at least one rate hike by the end of 2023. In fact, most are anticipating more than one rate hike. The median forecast for the end of 2023 is for the target federal funds rate to be 50 bps higher.
In the post-meeting press conference, Fed Chair Jerome Powell downplayed the importance of the dot plot by saying that the forecasts should be taken with a “big grain of salt.” The federal funds rate forecasts are based on assumed economic progress, and as we saw from 2008 to 2016, the dot plots have often been too optimistic.
In addition to the dot plot, there were big changes in the inflation and GDP median forecasts for 2021. The Fed’s preferred inflation measure, the core PCE, is forecasted to increase 3.0% in 2021. That’s a large increase from their March forecast of 2.2%. The GDP is forecast to increase 7.0%, up from 6.5% in March.
The inflation forecasts for 2022 changed little, which indicates that the Fed views the current inflation rise as just transitory. The core PCE for 2022 is forecast to rise 2.1%, up from 2.0% in March, and for 2023, both the June and March forecasts are the same at 2.1%.
In the post-meeting press conference, Fed Chair Powell specifically mentioned these inflation forecasts which highlighted the fact that they think the current rise in inflation will just be “transitory.” The inflation data this year will be especially important. If inflation keeps rising and if the Fed keeps moving up their inflation forecasts, that will point to inflation that may be more persistent than the Fed had expected.
The first sign of tightening from the Fed will likely be talk about tapering its asset purchases. In the post-meeting press conference, Fed Chair Powell said that “you can think of this meeting that we had as the ‘talking about talking about’ meeting.” The Fed should keep moving toward taper in 2021. The faster that inflation rises, the sooner taper will probably begin.
Fed Chair Powell is currently giving testimony to a House subcommittee on the Coronavirus Crisis. So far it has been a reinforcement of what he said in last week’s post-meeting press conference.
Banking Industry’s Deposit and Loan Levels
With the Fed’s zero rate policy in a holding pattern for the foreseeable future, two other factors will influence deposit rate changes in 2021 and 2022.
First, the deposit and loan levels at the banks will influence deposit rates. Since the pandemic began, government stimulus checks combined with lower spending has caused deposit levels to surge and loan balances to fall. 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. As I describe below, the latest CD rates at USAA Bank are examples of ridiculously low rates.
As the pandemic ends, consumer spending should rise and the government will hopefully wind down the stimulus checks. That should eventually allow deposit levels and loan balances at banks to return to their pre-pandemic condition, and banks will once again have to worry about attracting deposits.
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, and the data shows that deposit levels have again started a substantial rise after a couple of weeks of a small decline. Loan balances have also started to rise again, but at a much smaller pace. It will probably take a while for deposits to decline and loan balances to grow to the level that will put upward pressure on deposit rates.
For the previous week, Fed data released on June 11th showed that deposits in the banking industry declined $2.7 billion from May 26th to June 2nd. For that same period, loan balances declined $10.2 billion.
For the latest week, both deposits and loans balances increased. Deposits levels increased much more than loans which won’t be helpful for deposit rates. Fed data released on June 21st showed that deposits in the banking industry increased $78.3 billion from June 2nd to June 9th. For that same period, loan balances increased $16.4 billion.
The second factor that may impact deposit rates this year is the economy and Treasury yields.
The 2-year and 5-year Treasury yields had the largest gain in the last week while the 10-year and 30-year yields declined. The 2-year and 5-year yields are most sensitive to Fed rate changes. The new dot plot suggests that the Fed may hike rates sooner than expected to combat rising inflation. With the Fed appearing to be more concerned with inflation than had been thought before last week’s meeting, long-dated yields fell.
Short-dated yields also increased last week, but these yields continue to be near zero.
Odds of Fed Rate Hikes
The CME FedWatch Tool data had some major improvements in the last week. This is the tool which lists implied probabilities of future target federal funds rate hikes based on the Fed Funds futures market. The Tool now shows probabilities out to the July 2022 meeting. Previously, the Tool didn’t go past 2021. Another improvement is that the probabilities seem more reasonable and inline with the Fed’s dot plot. The odds of a 2021 rate hike are now zero. However, the odds rise way above zero in 2022, with a maximum probability of 32.4% for a higher rate by the July 2022 meeting.
Treasury Yields (Close of 6/21/2021):
- 1-month: 0.04% up 3 bps from 0.01% last week (0.13% a year ago)
- 3-month: 0.05% up 2 bps from 0.03% last week (0.15% a year ago)
- 6-month: 0.06% up 1 bp from 0.05% last week (0.17% a year ago)
- 1-year: 0.09% up 4 bps from 0.05% last week (0.18% a year ago)
- 2--year: 0.27% up 11 bps from 0.16% last week (0.19% a year ago)
- 5--year: 0.90% up 10 bps from 0.80% last week (0.33% a year ago)
- 10-year: 1.50% down 1 bp from 1.51% last week (0.70% a year ago)
- 30-year: 2.11% down 8 bps from 2.19% last week (1.47% a year ago)
Fed funds futures' probabilities of future rate changes by:
- Sep 2021 - up by at least 25 bps: 0.0%, down from 7.0% last week
- Dec 2021 - up by at least 25 bps: 0.0%, down from 6.7% last week
- Mar 2022 - up by at least 25 bps: 7.8% down from 12.3% last week
- July 2022 - up by at least 25 bps: 32.4% up from 27.1% last week
CD Interest Rate Forecasts
With the exception of one credit union, all of the noteworthy CD rate changes in the last week were rate cuts. On the positive side, there weren’t many rate cuts, and most of the cuts were small.
Abound Credit Union was the one credit union that increased a couple of its CD rates. Its 59-month CD yield increased 5 bps to 1.35%, which moved this CD in first place for nationally available 5-year CDs.
One example of small cuts was at First Internet Bank which lowered the rates of its long-term CDs by only one basis point. The new rates of its long-term CDs are now 0.95% (5-year), 0.85% (4-year), and 0.80% (3-year). The small rate cut is noteworthy since the previous 5-year CD rate (0.96%) had held since last October, and this rate has been near the rate leaders for online banks.
USAA Bank also had small rate cuts, but its rates are now so low that they can only fall by a few basis points before they reach zero. It’s hard to believe that USAA Bank is still cutting its CD rates. They’re now way below even the FDIC national averages. Its highest CD rate is now only 0.09%, and that requires a 7-year term. The 5-year CD rate fell to 0.06%, and the 1-year CD rate fell to 0.03%. Never has USAA Bank CD rates been close to these lows. Before 2020, the lowest 5-year rate for a USAA Standard CD was 1.06% from 2013 to early 2018.
Besides the few banks like USAA that keep lowering their rates to zero, CD rates overall appear to have stabilized at or near a bottom. The stabilizing of CD rates near a bottom can be seen in the Online CD Indexes. Since December, Online 1-year CD Index and Online 5-year CD Index have been falling very slowly. These indexes track the average rate of 10 well-established online CDs. For May, the Online 1-year CD Index had its first rate increase since January 2020, rising 1 bp from 0.44% to 0.45%.The Online 5-year CD Index didn’t have a rate increase, but the average held steady for the second straight month at 0.65%. The 1-year rate gain was small, but at least it’s a step in the right direction.
I’m only including one to three CD rate changes per institution to avoid an overload of data. All percentages listed below are APYs.
- Abound CU (59m 1.30% → 1.35%, 13m Spc 0.75% → 0.80%)
- First Internet Bank (5yr 0.96% → 0.95%, 3yr 0.81% → 0.80%)
- Limelight Bank (3yr 0.75% → 0.70%, 1yr 0.60% → 0.55%)
- Patelco CU (3yr 0.55% → 0.50%, 1yr 0.30% → 0.25%)
- Amerant (5yr 0.50% → 0.40%, 1yr 0.25% → 0.15%)
- USAA Bank (7yr 0.15% → 0.09%, 5yr 0.10% → 0.06%, 1yr 0.04% → 0.03%)
I’ll have more discussion of the CD rate changes in my CD rate summary later today.
There were just a couple of noteworthy rate changes of savings and money market accounts in the last week: all were rate cuts.
Most noteworthy was the rate cut at Salem Five Direct. Its eOne Savings account rate fell 5 bps to 0.40%. Salem Five Direct has a long online history. Its eOne Savings account was launched in 2009, and since then it has been fairly competitive. In 2019, the eOne Savings account yield reached a peak of 2.51%. Its pre-2020 low was 0.75% in 2012.
Overall, there are signs that rate declines may be coming to an end. Our Online Savings Account Index which tracks the average rate of 10 well-established online savings accounts had its first monthly increase since February 2019. The Online Savings Account Index increased 1 bp from 0.45% on May 3rd to 0.46% on June 1st. Just like the Online 1-year CD Index increase, it’s small, but it’s a step in the right direction.
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.
- Security State Bank Investment Savings ($100k+ 0.60% → 0.45%)
- Salem Five Direct eOne Savings (0.45% → 0.40%)
Economic and Deposit Rate Scenarios in 2021 and Beyond
The following is a review of four scenarios about how the economy and interest rates will evolve over the next few years. 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 completely recovered. Based on history, the odds of this happening appear low. However, as I described above, the odds of this appear to be rising. Thus, I”ve added a new scenario that takes this into account.
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 four scenarios is most likely to occur over the next decade:
- Surging inflation forces the Fed to act.
- Strong and fast economic recovery
- Slow economic recovery
- No sustained economic recovery
Surging inflation forces the Fed to act
April 2021 may go down in history as the first month of the post-pandemic inflation surge. The Consumer Price Index (CPI) for April far exceeded economists’ expectations. The year-over-year gain in the CPI was 4.2% and the month-to-month gain was 0.8%. Even core CPI (which excludes food and energy) far exceeded expectations. Core CPI increased 3% on a year-over-year basis and 0.9% on a monthly basis. The monthly rise in core CPI was the largest since 1981.
For the Fed to act on a surge of inflation, it will likely require that the surge proves to not be transitory. The Fed currently expects some spikes in inflation as the economy reopens, and it’ll take more than a couple of months of high inflation for the Fed to worry. It’s hard to say how many months of rising inflation it will take for the Fed to act. If rising inflation continues into 2022, the Fed will have a difficult time convincing the public that it’s only transitory.
As inflation starts to look less and less transitory, the markets will likely start to suffer with larger and larger corrections. This will probably force the Fed to maintain the transitory line until it finally has no choice but to admit that it has to act.
In this scenario, my guess is that the Fed would act sometime in 2022 after more than a year of rising inflation. The difficult question would be how the markets and the economy would respond. A recession seems likely. The bigger the crash and recession, the more likely that high rates would be short-lived. This would be the time to lock into long-term CDs. My parents did that in the early 80s with a 10-year CD that had a 16% APY.
It’s possible that the Fed may feel it cannot taper its bond buying or raise interest rates. In that case, we could keep living with rising inflation. It took quite a bit of time in the 70s before Volcker became Fed Chair and was willing to lead the Fed to hike rates to levels necessary to end high inflation. Thus, it may still take multiple years before we see rate hikes. Even if the Fed doesn’t tighten policy, long-dated bond yields may rise. That could impact CD rates.
Strong and fast 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 June Summary of Economic Projections, no FOMC participant expects a rate hike in 2021. Only seven out of the 18 expect at least one rate hike by the end of 2022, but 13 out of the 18 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.
Slow economic recovery
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.
No sustained economic recovery
If the pandemic, bad government policies or other factors prevent a sustained economic recovery, the Fed may hold 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.
Possible deposit rate changes in 2021 and 2022
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.
The rising long-term Treasury yields in 2021 have contributed to the rise of long-term brokered CD rates. This may lead to a rise of long-term direct CDs in 2021 and 2022. However, one thing that is different today than in 2013 and 2014 is the surge of deposits at banks and credit unions. The government stimulus checks combined with lower leisure spending in 2020 have contributed to record deposit increases at banks and credit unions. Most banks don’t need deposits, and thus, they are free to lower deposit rates to record low levels. This helps explain why even some online banks are offering incredibly low deposit rates (as examples, Citizens Access 1-year Online CD at only 0.10% and Barclays 5-year online CD at only 0.25%).
Future Rates and CD Term Decisions
It’s possible that we will see a strong economic recovery and/or a steady increase in inflation in the second half of 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 year, 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 late 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 0.60%. If you do want to hold CDs, at least make sure that the CD rate is at least higher than 0.60%.
The difficult decision for savers is trying to decide when it’s the right time to lock into long-term CDs. When you see a new higher rate, is it a sign that higher rates are coming which suggests you should wait? Or if you see that a CD rate has reached a certain high (like 2% or 3%), should you acquire that CD? As I mentioned above, it may seem prudent to wait, but as we’ve seen in the past 10 years, rates rarely rise as much as we expect. Once the Fed starts hiking rates, the rate hikes may not last long.
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 May 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 (0.132%) is also at a 5-year low. The previous low was 0.177% in December 2016.