Federal Reserve, the Economy and CD Rate Forecast - June 18, 2019

The Fed’s two-day meeting started today. The meeting announcement is scheduled for 2:00 PM EDT Wednesday. Along with the announcement, the Fed will be releasing its quarterly Summary of Economic Projections, which includes the “dot plot” that shows FOMC participants’ expectations of the future federal funds target rate. Following these releases, a press briefing by Fed Chair Jerome Powell will take place. No rate change is expected at this Fed meeting. The “pause” period that began earlier this year will likely continue.

It should be noted that a Fed rate cut on Wednesday can’t be ruled out. One thing that should prevent a rate cut is recent economic data that indicates that growth isn’t slowing down in a significant way. As economist Tim Duy described in his recent Fed Watch blog post:

this past week’s readings on consumer spending and manufacturing suggest the economy is nowhere near teetering into a recession and will give ammunition to the wait-and-see crowd on the FOMC.

Even though the Fed will probably not cut rates, there are expectations that the Fed will change its language in their statement to open the door for rate cuts later this year. Tim Duy predicted this change to the statement:

I expect the Fed will signal that a more dovish stance by replacing “the Committee will be patient” with “the Committee will act as appropriate” to sustain the expansion.

If we see that language change, the odds of a rate cut at the Fed’s July meeting will likely rise. Our best hope to avoid a rate cut is if the June jobs report (that will be released on July 5th) shows strong job growth that offsets the weak May report.

The markets currently view a July Fed rate cut as almost a sure thing. The Fed Funds futures (via the CME FedWatch Tool) are showing odds of 87.7% that the federal funds target rate will be lower after the July meeting. They are showing odds of only 1% that there will be no rate cuts by the December meeting. The odds that the federal funds target rate will be at least 50 bps lower by December are now at 87.0%, up from 79.2% last week.

With the rising odds of Fed rate cuts, yields of Treasury bills have fallen. These short-dated Treasury yields tend to more closely follow federal funds rate expectations. The 1-month Treasury yield had the largest decline, falling 8 bps from two weeks ago. The longer-dated yields weren’t far behind. Both the 5-year and 10-year yields were down by 6 bps. The 5-year yield was at 1.85% yesterday. That’s almost one percentage point lower than it was a year ago.

The 10-2 spread (the difference between the yields of the 10-year and 2-year Treasury Notes) narrowed a bit from two weeks ago. It’s now 23 bps, down from 25 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 6/17/19):

• 1-month: 2.22% down from 2.30% last week (1.82% a year ago)
• 6-month: 2.20% down from 2.21% last week (2.07% a year ago)
• 1-year: 2.03% same as last week (2.35% a year ago)
• 2--year: 1.86% down from 1.90% last week (2.55% a year ago)
• 5--year: 1.85% down from 1.91% last week (2.81% a year ago)
• 10-year: 2.09% down from 2.15% last week (2.93% a year ago)
• 30-year: 2.58% down from 2.62% last week (3.05% a year ago)

Fed funds futures' probabilities of future rate CUTS by:

• Jun 2019 - down by at least 25 bps: 19.2% up from 17.5% last week
• Jul 2019 - down by at least 25 bps: 87.7% up from 78.9% last week
• Sep 2019 - down by at least 25 bps: 97.2% up from 91.5% last week
• Dec 2019 - down by at least 25 bps: 99.0% up from 97.1% last week
• Dec 2019 - down by at least 50 bps: 87.0% up from 79.2% last week
• Dec 2019 - up by at least 25 bps: 0.0% same as last week

CD Interest Rate Forecasts

As I mentioned last week, the increased odds of Fed rate cuts will only accelerate CD rate cuts. If the Fed changes policy at its meeting by replacing its current “pause” policy to a policy that is preparing the markets for a rate cut, CD rate cuts will almost certainly accelerate.

Fortunately, we are still not seeing any widespread large downward movement in the most competitive direct CD rates, but there have been several small rate cuts, and large rate cuts are becoming more common. Institutions that have recently cut rates include Ally Bank (5-year fell from 3.00% to 2.85%) and Discover Bank (5-year fell from 3.00% to 2.85%). I’ll provide more details in my CD summary later today.

The only way we will see a reversal of these CD rate cuts is if we see a steady stream of strong economic data and rising inflation expectations. That will eventually cause the Fed to return to a hawkish stance. However, if the economy weakens and the Fed starts to hint about a rate cut (or actually cuts rates), CD rate declines will likely accelerate.

With the odds of Fed rate cuts increasing to such high levels, it’s looking more and more likely that the rate hiking cycle is long over. I don’t think it’s wise to wait any longer for higher rates. The highest odds still point to us having reached the peak of this rate hiking cycle. If you want yields of at least 3%, it’s now time to seriously consider mid-term and long-term CDs. If CD rate cuts continue, 3% CDs will soon be gone.

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 have increased in the last two years with the largest gains occurring in early 2018. One important recent trend to note is that the slope of rising rates has flattened in the last few months.

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.