The Labor Department released the August Consumer Price Index (CPI) report this morning, and the inflation numbers were below expectations. CPI increased 0.3% for the month, which was below the expected 0.4% increase. Core CPI, which excludes food and energy, increased 0.1% for the month, which was below the expected 0.3% increase. Even though these numbers are below expectations, they’re still elevated. The year-over-year CPI is 5.3%, a level that hasn’t been seen before 2021 in about 13 years. However, we may have passed the peak. Last month’s year-over-year CPI was 5.4%.
The Fed has been claiming that this year’s inflation surge would just be transitory. They will likely use this CPI data to justify a continuation of that claim.
The Fed shouldn’t be too confident in its transitory claim. Yesterday, The New York Fed released its August Survey of Consumer Expectations. The expectations of those surveyed are for inflation to be 5.2% a year from now and 4.0% three years from now. Not only are these up from last month, they are the highest readings since the survey began in 2013. Consumer expectations of future inflation can prove self-fulfilling.
Also, many economists are forecasting longer-lasting inflationary pressures that could prove the transitory camp wrong. According to this WSJ article:
Economists anticipate that broader, longer-lasting inflationary pressures will emerge in coming quarters. For example, many expect a rebound in rent to buoy overall CPI in the months ahead.
Next week’s Fed meeting which will include an update to the Fed’s Summary of Economic Projections (SEP) should be interesting. The Fed’s inflation forecasts from June will likely be revised higher. That may show the Fed’s confidence about inflation being transitory. The SEP also includes the dot plot which shows Fed member expectations about the future federal funds rate. In June most of the Fed members anticipated at least one rate hike by the end of 2023. It’ll be interesting to see if this moves to 2022.
Another expectation from next week’s Fed meeting are signals about tapering of the Fed’s asset purchases. With the weak August jobs report, few are expecting that the Fed will announce the start of tapering at next week’s meeting. However, there is an expectation that the Fed will signal that it may soon announce tapering, which will open the door for the formal announcement at the Fed’s November meeting. The start of tapering is the first step in the long-road to the first Fed rate hike (liftoff). Thus, the sooner tapering begins, the sooner liftoff will occur.
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 America’s personal savings rate to soar which has increased deposit levels at banks to record 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 September 10th showed total deposits of $17,536.2 billion and total loans of $10,462.3 billion. From last week, deposits increased $37.4 billion, and loans increased $20.1 billion. This is the fourth straight week of deposit growth that’s larger than the loan growth. However, deposit growth has slowed while loan growth has picked up. That’s a small step in the right direction. From July, deposits are up $324.2 billion and loans are up $84.8 billion. For the last two-month period, deposit growth remains well above loan growth. It may take years of falling deposit balances and growing loan balances before loan-to-deposit ratios reach normal levels that will encourage higher deposit rates.
The second factor that may impact deposit rates this year is the economy and Treasury yields.
The lower-than-expected CPI numbers appear to be weighing on Treasury yields this morning. From last week to the close of Monday, Treasury yield changes were mixed. The 5-year yield was up 3 bps, the 10-year yield had no change, and the 30-year yield was down 3 bps. Shorter-dated Treasury yields had little change, with no change in the 2-year yield and a decline of only 1 bp in the 1-year yield.
Odds of Fed Rate Hikes
The odds of a Fed rate hike in 2022 and 2023 were down from last week according to the CME FedWatch tool. Also, the odds of a December 2021 rate hike are now back down to zero. The CME FedWatch tool lists implied probabilities of future target federal funds rate hikes based on the Fed Funds futures market. In the last several months, the odds of a rate hike at the December 2021 meeting had been zero, but that changed last week with odds of 1.7%. Perhaps the lower-than-expected CPI numbers eliminated those slight odds that inflation could surge to such an extent that it could force the Fed to act fast. The odds of one or more rate hikes by December 2022 were 49.3% early this afternoon, down from 53.3% last week.
Treasury Yields (Close of 9/13/2021):
- 1-month: 0.06% up 2 bps from 0.04% last week (0.10% a year ago)
- 3-month: 0.06% up 1 bp from 0.05% last week (0.11% a year ago)
- 6-month: 0.06% up 1 bp from 0.05% last week (0.12% a year ago)
- 1-year: 0.07% down 1 bp from 0.08% last week (0.13% a year ago)
- 2--year: 0.21% same as last week (0.13% a year ago)
- 5--year: 0.81% up 3 bps from 0.78% last week (0.26% a year ago)
- 10-year: 1.33% same as last week (0.67% a year ago)
- 30-year: 1.91% down 3 bps from 1.94% last week (1.42% a year ago)
Fed funds futures' probabilities of future rate changes by:
- Sep 2021 - up by at least 25 bps: 0.0%, same as last week
- Dec 2021 - up by at least 25 bps: 0.0%, down from 1.7% last week
- Mar 2022 - up by at least 25 bps: 0.0%, down from 3.4% last week
- July 2022 - up by at least 25 bps: 9.2%, down from 17.7% last week
- Dec 2022 - up by at least 25 bps: 49.3%, down from 53.3% last week
- Feb 2023 - up by at least 25 bps: 54.5%, down from 57.1% last week
Deposit Rate Changes and Forecasts
Just a few banks and credit unions had noteworthy CD rate changes. The good news is that two of these changes were rate increases.
Navy Federal Credit Union rate increases just impacted their Jumbo CDs which require a minimum deposit of $100k. Rates for all terms increased 5 bps. The new rates are 0.95% (5- and 7-year), 0.75% (3-year), 0.60% (2-year, 18-month and 1-year), 0.50% (6-month), and 0.45% (3-month).
Market USA FCU just increased its long-term CD rates. Its 5-year CD rates had the largest increase. The regular 5-year rate increased 35 bps to 0.65%, and the preferred 5-year rate increased 35 bps to 1.00%. The 4-year rates had smaller increases. The regular 4-year rate increased 10 bps to 0.35%, and the preferred 4-year rate increased 10 bps to 0.70%.
The one institution that cut rates was Presidential Bank. The rates of its CDs with terms from six months to five years fell 40 bps. These cuts have moved their rates from near average for online banks to well below average. Examples include 0.10% for a 1-year CD (average is 0.46%) and 0.25% for a 5-year CD (average is 0.68%).
The big rate cuts at Presidential Bank may be due to how its loans and deposit levels have changed in the last year. Total loan balances have gone down 1.6%, while total deposits have grown by 28.3%. This resulted in a loan-to-deposit ratio that has fallen from 90.0% to 68.9%.
Even though there have been a few institutions like Presidential Bank that have made large CD rate cuts, the average CD rate has started to inch up, with slightly larger increases on long-term CDs. This can be seen in the September Online CD Indexes. These Indexes are essentially the average CD rates from ten well-established online banks.
The Online 5-year CD Index increased 2.5 bps in September, rising from 0.650% to 0.675%. This is the first monthly rate increase since December 2018. Long-term CD rates actually began falling in early 2019 when the Fed ended its rate hikes in December 2018. When the pandemic began, there were large monthly rate cuts for most of 2020. That changed in 2021. The Index has fallen at a very slow pace in 2021, with three months of no rate changes.
The Online 1-year CD Index also increased in September, but the increase was small, rising 0.50 bp to 0.456%. Online 1-year CD rates haven’t moved much this year. When January began, the Index was at 0.465%, which is just 0.9 bp above where it’s at now.
I’m only including one to three CD rate changes per institution to avoid an overload of data. All percentages listed below are APYs.
- Market USA FCU (5y Prfd 0.65% → 1.00%, 4y Prfd 0.60% → 0.70%)
- Navy FCU (5y Jbo 0.90% → 0.95%, 1yr Jbo 0.55% → 0.60%)
- Presidential Bank (5y 0.65% → 0.25%, 1y 0.50% → 0.10%)
Savings, Checking and Money Market Rates
There were just a couple of noteworthy liquid account rate changes in the last week.
Two of the rate changes occurred on reward checking accounts, and both did not affect the primary rates. The cuts applied to the upper tiers.
Like the CD rate cuts, Presidential Bank made a significant rate cut to its Advantage Checking Account. However its primary rate for balances up to $25k when monthly requirements are met remains at 2.25% APY. The rate for balances over $25k fell from 0.65% to 0.40%. This results in a decline of the blended APYs for balances over $25k. For example, the blended APY for a $100k is now 0.86%, which is down from 1.05%.
The other reward checking account with a second-tier rate change was Quontic Bank. Its second-tier rate fell from 0.65% to 0.35%. However, its primary rate (1.01% APY) now applies to larger balances ($150k, up from $100k). Also, blended APYs now apply for balances above the first tier. This results in higher APYs for large balances. I’ll have more details in my liquid account rate summary.
For September, 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%. This rate has been falling slowly in 2021. When 2021 started, the Index was at 0.512%.
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.
- Presidential Bank Advantage Checking 2nd tier (0.65% → 0.40%)
- Quontic Bank High Interest Chk 2nd tier (0.65% → 0.35%)
I’ll have more discussion of the liquid account rate changes in my liquid account summary later today.
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.
Inflation data from April through July continues to show high inflation. The year-over-year core PCE, the Fed’s preferred inflation measure, has increased by 3.1% in April, 3.5% in May, and 3.6% in both June and July.
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 few 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 since the markets are so dependent on ultra low rates. 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 1980s 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 1970s 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. These factors are starting to have an effect on the economy in late 2021. 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 early 2021 have contributed to the rise of long-term brokered CD rates. However, long-term yields have mostly fallen in the second quarter of 2021, and increases in brokered CD rates have moderated.
Unlike 2013, there are no signs yet of any taper tantrum. Thus, we may not see any CD rate hikes like we saw in 2013 and 2014.
Another 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, USAA Bank 1-year CD at 0.03%, Citizens Access 1-year Online CD at 0.10% and Barclays 5-year online CD at 0.25%).
Future Rates and CD Term 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 1.40% 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 rather than 2023. 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 from March 2020 to August 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 (0.128%) is also at a 5-year+ low. The previous low was 0.177% in December 2016. One thing apparent in the charts is that the declines in rates have slowed in 2021 for all products. This suggest that deposit rates won’t fall too much more from current levels.