Today’s speech by Fed Chair Jerome Powell and his Congressional testimony last week have been interpreted by the markets and by many economists that the Fed will likely cut rates at its July 30-31 meeting. In the speech delivered today at a conference in Paris, the Fed Chair essentially repeated what he said last week about his view of a strong U.S. economy with growing risks:
In our baseline outlook, we expect growth in the United States to remain solid, labor markets to stay strong, and inflation to move back up and run near 2 percent. Uncertainties about this outlook have increased, however, particularly regarding trade developments and global growth. In addition, issues such as the U.S. federal debt ceiling and Brexit remain unresolved. FOMC participants have also raised concerns about a more prolonged shortfall in inflation below our 2 percent target.
The minutes from the June Fed meeting were released last week, and according to this MarketWatch article, the “minutes just show that Powell has the backing of most Fed officials for a move.”
However, not everyone on the Fed has bought into a rate cut as this Bloomberg article describes:
Two regional Federal Reserve bank chiefs pushed back Thursday against the growing consensus view that the central bank is all but certain to cut rates at its July 30-31 meeting, contending the economy is doing just fine and inflation is near their 2% target.
This push back on a rate cut may not be enough to prevent a 25-bps rate cut, but it should at the very least prevent a 50-bps rate cut at the July meeting. If the Fed does follow through on a rate cut, it may not signal that we’re beginning a rate cutting cycle with a recession and a long period of zero rates. In the period from 1995 through 2000, the target federal funds rate was only cut a few times. The rate never fell below 4.75%. A peak of 6.50% was reached in 2000. So if the economy stays strong and the uncertainties and risks mentioned by the Fed Chair diminish, it’s possible we won’t see any more than two or three rate cuts this year, and then we’ll return to a pause period and then back to rate hikes.
If the Fed does cut rates in July, it’s important that we recognize that it’s an insurance cut, and if the insurance “works”, there won’t be too many additional cuts. In his recent Fed Watch blog post, the economist Tim Duy provided an interesting description of this insurance rate cut and why it may not lead to that many additional cuts:
The Fed is taking out insurance against increasing downside risks given that the cost of that insurance is cheap given low inflation. Eventually future rate cuts will have to be about the data not just the risks.
The markets have definitely bought into a July rate cut. The Fed Funds futures markets (via the CME FedWatch Tool) are still pricing in a 100% chance of a rate cut at the July meeting. The odds of a larger rate cut have gone up quite a bit from last week. The odds that the rate cut will be at least 50 bps are now 27.6%, up from 3.8% last week. By the end of the year, the odds that the federal funds rate will be at least 75 bps lower are now 54.0%, up from 40.5% last week.
Treasury yield changes were mixed. All of the short-dated yields fell from last week with the 6-month and 2-year yields falling the most (both fell 9 bps). The long-dated yields had slight gains. The 10-year yield increased 2 bps, and the 30-year increased 7 bps.
Due to the fall of the 2-year yield and the rise of the 10-year yield, the 10-2 spread (the difference between the yields of the 10-year and 2-year Treasury notes) widened from last week. It’s now 26 bps, up from 15 bps last week. A negative 10-2 spread has a history of preceding recessions.
Treasury Yields (Close of 7/15/19):
- 1-month: 2.17% down from 2.22% last week (1.87% a year ago)
- 6-month: 2.06% down from 2.15% last week (2.16% a year ago)
- 1-year: 1.95% down from 2.00% last week (2.37% a year ago)
- 2--year: 1.83% down from 1.92% last week (2.59% a year ago)
- 5--year: 1.84% down from 1.88% last week (2.73% a year ago)
- 10-year: 2.09% up from 2.07% last week (2.83% a year ago)
- 30-year: 2.61% up from 2.54% last week (2.94% a year ago)
Fed funds futures' probabilities of future rate CUTS by:
- Jul 2019 - down by at least 25 bps: 100% same as last week
- Jul 2019 - down by at least 50 bps: 27.6% up from 3.8% last week
- Sep 2019 - down by at least 50 bps: 71.1% up from 57.1% last week
- Dec 2019 - down by at least 50 bps: 88.8% up from 82.7% last week
- Dec 2019 - down by at least 75 bps: 54.0% up from 40.5% last week
CD Interest Rate Forecasts
CD rate cuts have continued in the last week. It appears that most banks and credit unions are probably anticipating a Fed rate cut in July.
In the last week, we have seen several more banks and credit unions cut their CD rates. Just a few recent examples of institutions that have cut rates include Ally Bank (5-year fell 10 bps to 2.75% APY), Synchrony Bank (1-year fell 5 bps to 2.50% APY), Comenity Direct (5-year fell 10 bps to 2.95% APY, 1-year fell 15 bps to 2.65% APY), First Internet Bank (5-year fell 8 bps to 2.84% APY, 1-year fell 5 bps to 2.63% APY), and Alliant Credit Union (5-year fell 15 bps to 2.70% APY). I’ll have more details later today in my CD summary.
As I mentioned above, it’s possible that an “insurance rate cut” will work to prevent a major economic slowdown. In that case, we could only see one or two Fed rate cuts this year. If that happens, the Fed could eventually get back to talking about rate hikes and CD rates should start rebounding. In this scenario, it may not be wise to load up too heavily on long-term CDs.
The current odds still point to a substantial period of falling rates. So I still 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. There are still a few 3% CDs that are nationally available at both banks and credit unions. I don’t think 3% CDs will be around for much longer. A 3% CD special may pop up now and then, but I’m afraid those specials will probably be rare.
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 not rising like they were in 2018 and early 2019. Most of the averages are now starting to 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.