Federal Reserve, the Economy and CD Rate Forecast - Dec 18, 2018

This is my third weekly review of the Fed, the economy and what we can expect of future deposit rates. My weekly summaries will now be focused entirely on deposit rates and deals, and they will be published on Tuesday evenings (My CD summary is now available at this link). This change was done to separate the economic and political discussion from the deal discussion. Often economic discussion leads to political discussion, and that can create lots of comments which drown out comments on deals and rates. To avoid that, please limit comments related to the Fed, the economy and politics to these blog posts.

The Fed’s two-day meeting started today. The meeting announcement is scheduled for 2:00 PM ET Wednesday. A Fed Funds rate hike of 25 bps is expected, but it’s not a sure thing. In addition to the meeting announcement, the FOMC forecasts will be released. These include the “dot plot” which shows the projections of future Fed Funds rates. Lastly, at 2:30 PM, Fed Chair Jerome Powell will be holding a press briefing.

The Fed is facing a lot of headwinds for continuing on its gradual rate hike path. On Monday, the Wall Street Journal editorial board published an opinion piece titled “Time for a Fed Pause.” The piece claimed that low inflation, signs of slowing economic growth, trade uncertainty and the uncertainty of reducing the Fed’s balance sheet all support the case of pausing at this meeting.

I think the WSJ’s piece is too pessimistic on the economy. Economist Tim Duy explains in his latest Fed Watch blog post that recent economic data continues to support the Fed’s gradual rate hike policy:

Recent data remain largely consistent with the Fed’s outlook. As a reminder, the Fed’s forecast anticipates the growth will ease in 2019 relative to this year but remain at a pace that would continue to intensify inflationary pressures. In short then the Fed expects growth to slow on the back of past rate hikes and waning fiscal stimulus. I don’t think the Fed will view incoming data as inconsistent with that outlook.

Tim Duy does admit that other issues may impact the Fed:

The Fed doesn’t like to move on market moves alone. That said, with equity markets tumbling to 14-months lows, it seems easy to make the case that the Fed should opt to simply skip this month and come back to the table in January.

As we know from the Fed’s history from 2009 to 2016, they often side with holding rates steady rather than raising them.

So the Fed meeting announcement on Wednesday should offer some excitement. Even if the Fed follows through with the expected rate hike, the Fed may disappoint us in what it says about next year. There will likely be some changes to the statement, to the dot plot and in the press conference that point to a move dovish policy with fewer future rate hikes.

The odds of future Fed rate hikes did drop from last week according to the Fed Fund futures as indicated by the CME FedWatch Tool. The odds of a rate hike on Wednesday is now 71.5%, down from 78.4% last week. The odds of additional rate hikes also went down. The odds that the federal funds rate will be up by at least 75 bps in June (3 rate hikes) is now only 5.0%, down from 10.8% last week.

Treasury yields have changed little from a week ago. The yield curve (as defined by the difference between the yields of the 10-year and 2-year Treasury notes) actually widened a bit with the 2-year yield falling 2 bps while the 10-year yield increased 1 bps. The spread between the 2-year and 10-year yields is now 16 bps.

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

Treasury Yields (Close of 12/17):

• 1-month: 2.36% up from 2.32% last week (1.24% a year ago)
• 6-month: 2.54% same as last week (1.48% a year ago)
• 1-year: 2.66% down from 2.69% last week (1.71% a year ago)
• 2--year: 2.70% down from 2.72% last week (1.84% a year ago)
• 5--year: 2.69% down from 2.71% last week (2.16% a year ago)
• 10-year: 2.86% up from 2.85% last week (2.35% a year ago)
• 30-year: 3.11% down from 3.13% last week (2.68% a year ago)

Fed funds futures' probabilities of future rate hikes by:

• Dec 2018 - up by at least 25 bps: 71.5% down from 78.4% last week
• Mar 2019 - up by at least 50 bps: 19.7% down from 27.5% last week
• Jun 2019 - up by at least 75 bps: 5.0% down from 10.8% last week

CD Interest Rate Forecasts

With the odds of future Fed rate hikes diminishing, banks and credit unions are unlikely to be aggressive with their CD rates. That’s especially the case with long-term CD rates. Lower long-dated Treasury yields also point to disappointing long-term CD rates. With a 10-year Treasury yield that’s under 3%, I don’t think we’ll see widespread 4% CDs anytime soon.

As I mentioned last week, if the Fed decides to pause on rates this Wednesday, it may be time to start to seriously look into at least a few long-term CDs. A pause wouldn’t mean that it’s time to move everything into long-term CDs. It’s unlikely that we’ll see any widespread CD rate cuts anytime soon.

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 year with the largest gains occurring after February 2018.