Federal Reserve, the Economy and CD Rate Forecast - July 7, 2020

The June jobs report that was released last Thursday showed jobs gains that were well above economists’ expectations. The surprisingly good jobs reports for both May and June suggest that the recovery may be stronger than economists had been expecting. However, the recent COVID-19 surges that are causing states to roll back some re-openings may make further positive job gain surprises less likely. As economist Tim Duy described in his latest Fed Watch blog post, “We still have a long climb ahead of us to return to pre-Covid employment levels.”

The Fed is well aware of the long climb ahead. The minutes of the Fed’s June meeting were released last week, and they provided additional focus of the Fed’s concerns:

Members further concurred that the ongoing public health crisis would weigh heavily on economic activity, employment, and inflation in the near term and posed considerable downside risks to the economic outlook over the medium term.

On the plus side, there continues to be no sign that the Fed is thinking of negative rates. As Tim Duy said in his review of the minutes:

Of all the things the Fed seems inclined to do, negative interest rates are at the bottom of the list.

Instead of negative rates, the Fed may try other tools such as yield curve control (YCC). This would involve the Fed buying longer-term bonds in amounts that would force down long-term interest rates. Just like the federal funds rate directly impacts short-term rates, YCC targets longer-term rates. Unfortunately for savers, the Fed would try to lower longer-term rates with the intent of providing more stimulus for the economy. If the economic recovery slows, the odds of the Fed using YCC rises. Here’s how Tim Duy expects future Fed policy will evolve:

I think YCC is still likely, but that enhanced forward guidance will come first and then, as the recovery remains subpar, the Fed will feel pressure to do more and YCC will be the path of least resistance. Probably looking at 2021 before that happens.

The Fed’s policies and the path of future interest rates all depend on how quickly the economy recovers. San Francisco Fed President Mary Daly gave her opinions last week on this issue (via Bloomberg):

“If we can get the public health issues under control either through a really robust mitigation strategy or a vaccine, then we can reengage in economic activity really quickly,” [...] “Then it could take just four years or five years. But if we end up with a pervasive, long lasting hit to the economy, then it could take longer.”

If it does take four or five years for the economy to recover, we may not see the first Fed rate hike until 2025 or later. Once the economy does recover, the Fed won’t be in a rush to hike. As we saw at the end of the last zero rate period, it can be a long time for the Fed to significantly hike rates. The Fed did its first rate hike in December 2015. An entire year went by before the Fed hiked again in December 2016. The Fed finally started to slowly hike in 2017. It wasn’t until mid-2017 when we finally started to see significant impacts to deposit rates.

For about a month before the June 10th Fed meeting, the Fed Funds futures market (via the CME FedWatch Tool) was showing slight odds of a rate hike through March 2021. Once the June 10th Fed meeting took place with the new economic projections that showed no expectations for rate hikes through 2022, the Fed Funds futures have shown zero odds of any rate hikes through March 2021.

Due to a “zero bound” assumption used by CME, the CME FedWatch Tool still shows no chance of negative rates in the future.

Short-dated Treasury yields changed little from last week. They continue to be near zero, with yields ranging from 0.12% for the 1-month T-bill to 0.16% for the 2-year Treasury note. Long-dated Treasury yields were up slightly from last week. The 10-year was up 3 bps to 0.69%, and the 30-year was up 4 bps to 1.45%.

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

Treasury Yields (Close of 7/6/20):

• 1-month: 0.12% down 1 bp from 0.13% last week (2.26% a year ago)
• 3-month: 0.15% down 1 bp from 0.16% last week (2.23% a year ago)
• 6-month: 0.16% down 2 bps from 0.18% last week (2.14% a year ago)
• 1-year: 0.16% same as last week (1.98% a year ago)
• 2--year: 0.16% same as last week (1.87% a year ago)
• 5--year: 0.31% up 2 bps from 0.29% last week (1.84% a year ago)
• 10-year: 0.69% up 3 bps from 0.66% last week (2.04% a year ago)
• 30-year: 1.45% up 4 bps from 1.41% last week (2.54% a year ago)

Fed funds futures' probabilities of future rate changes by:

• Sep 2020 - up by at least 25 bps: 0.0% same as last week
• Dec 2020 - up by at least 25 bps: 0.0% same as last week
• Mar 2021 - up by at least 25 bps: 0.0% same as last week

CD Interest Rate Forecasts

As is typical for the start of the month, several credit unions made rate changes last week with the start of July. Unfortunately, the vast majority were rate cuts. The few credit unions that were offering 2% 5-year CDs in early June now have 5-year CD rates in the mid 1% range. The few online banks that were offering 5-year CDs in the mid 1% range in early June now have 5-year CD rates in the low 1% range. Several credit unions and online banks have been lowering their CD rates below 1%.

I’m hesitant to say we’re nearing a bottom for CD rates. After less than four months into this zero rate period, we have already seen all-time CD rate lows at a few credit unions and online banks. PenFed is the latest one. Its 5-year CD yield fell last week from 1.20% to 1.00%. That’s the lowest yield we have ever recorded for PenFed’s 5-year term since we began tracking rates in 2009. The previous low was 1.15% for the period of May 2013 through August 2013.

The one tiny bit of good news this week is a small rate hike at Communitywide FCU. Its 5-year CD yield increased from 1.25% to 1.35%.

Since there were so many rate cuts in the last week, I’m only listing rate cuts that are most interesting for DA readers. Also, I’m only including one to three CD rate changes per institution to avoid an overload of data. All percentages listed below are APYs.

• Georgia’s Own CU (5yr 1.90% → 1.70%, 1yr 1.30% → 1.15%)
• State Department FCU (5yr 1.66% → 1.51%, 2yr 1.26% → 1.21%)
• TruStone Financial CU (5yr 1.70% → 1.50%, 1yr 1.00% → 0.90%)
• First Internet Bank (5yr 1.36% → 1.31%, 1yr 1.06% → 1.01%)
• Communitywide FCU (5yr 1.25% → 1.35%, 1yr 1.25% → 1.20%)
• Limelight Bank (3yr 1.20% → 1.15%, 1yr 1.15% → 1.10%)
• PenFed CU (5yr 1.20% → 1.00%, 1yr 0.95% → 0.70%)
• Rising Bank (3yr 1.10% → 1.00%, 18m Rising 1.05% → 0.98%, 1yr 1.05% → 0.98%)
• Citizens Access (5yr 1.15% → 1.00%, 1yr 1.00% → 0.85%, 11m LCD 0.85% → 0.75%)
• NASA FCU (49m Spc 1.35% → 0.90%, 15m Spc 1.10% → 0.70%, 9m Spc 1.50% → 0.65%)
• Alliant CU (5yr 0.90% → 0.75%, 1yr 0.80% → 0.65%)

Like CD rates, online savings and money market account rates continue to fall toward 1% and under. Six more reached 1% in the last week. These include Citizens Access Online Savings Account and Comenity Direct High-Yield Savings Account. The Comenity Direct account had reached a yield of 2.48% between April and June 2019.

A few online savings account rates fell below 1%. Alliant Credit Union Savings Account rate fell from 0.90% to 0.75%. This savings account has a long history with rates that have remained competitive with the savings accounts at online banks. In 2019, the yield reached a high of 2.10% from February through August. The current 0.75% rate is just 5 bps above Alliant’s all-time low of 0.70% that occurred in 2013 and 2014.

Just like CDs, I’m hesitant to say that we are nearing a bottom for online savings account rates. Based on how Alliant Credit Union and others have been cutting, we may see a bottom lower than what we saw during the last zero rate period. During that period, online savings account rates generally bottomed in a range from 0.70% to 1.00%.

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.

• SFGI Direct Savings (1.36% → 1.16%)
• Axos Bank High Yield Savings (1.30% → 1.10%)
• Amboy Direct Personal eSavings (1.15% → 1.05%)
• FitnessBank Savings, 12.5+ steps (1.20% → 1.05%)
• Prime Alliance Bank Personal Savings (1.25% → 1.01%)
• Citizens Access Online Savings (1.15% → 1.00%)
• PenFed CU Premium Online Savings (1.05% → 1.00%)
• Communitywide FCU High Rate Quarterly (1.50% → 1.00%)
• Northern Bank Direct Money Market (1.25% → 1.00%)
• Comenity Direct High-Yield Savings (1.10% → 1.00%)
• Rising Bank High Yield Savings (1.10% → 1.00%)
• Virtual Bank eMoney Market Special (1.25% → 1.00%)
• TAB Bank High Yield Savings (1.10% → 0.90%)
• Alliant CU Savings (0.90% → 0.75%)
• TIAA Bank YP Money Market intro (1.01% → 0.75%)

I’ll have more discussion of the savings and money market rate changes in my liquid account summary later today.

Scenario #1: Pandemic wanes and the economy surges back

The latest Fed forecasts and the recent resurgence of COVID-19 cases have lowered the odds that the economy surges back. Nevertheless, this scenario of the economy recovering quickly as the pandemic subsides (either on its own or due to vaccines and new treatments) is still a possibility. If that occurs, the U.S. avoids a major recession, and the economy surprises on the upside later this year. As the San Francisco Fed President Mary Daly said last week, it could take four to five years for the economy to fully recover in the best case scenario.

Once the economy has reached full recovery, we’ll then have to wait on the Fed to feel confident about the recovery before it starts hiking rates. This could take a year or more as it did in 2015 to 2017. It’s possible that rising inflation could force the Fed to hike rates, but recent inflation data doesn’t support that. I’m going to maintain my best-case date of 2023 for when the Fed goes back to rate hikes. This is probably overly optimistic, but I’m going to keep it for now.

Scenario #2: Economy falls into a major recession and CD rates remain low for years

As we’ve seen in the last month, other negative shocks to the economy besides the pandemic are possible, and these shocks could result in the economy experiencing a major recession. And as we are seeing, the COVID-19 pandemic may not end anytime soon. The longer the pandemic impacts businesses, the more business closures and permanent layoffs will result. That could lead to a long-term recession.

There’s also the possibility that the pandemic or another shock will burst the debt bubble, causing an economic meltdown with a wave of business closures and panic in the financial markets. The Fed has so far been able to keep the financial markets running, and I don’t see a significant risk of an economic meltdown happening in the near term.

If a major recession does occur, the Fed will likely follow a path similar to the one it took after the 2008 recession. It may not take seven years of the zero bound before we see the next Fed rate hike, but in this #2 scenario, it will likely take at least five years for the U.S. economy to recover to the point in which the Fed will start hiking again.

Future Rates and CD Term Decisions

Now that the Fed has returned rates to the zero bound, we can look to the zero-bound years from 2008 to 2015 to help predict what we’ll see in deposit rates. During those years, it did become difficult to find long-term CD rates over 2%, but there were a few rare times when 3% CDs became available. PenFed’s 2013 CDs are an example. I doubt we’ll see any 3% CDs for a while. In fact, it looks like 2% CDs will probably be non-existent for the remainder of this year. That could change in 2021 if a strong recovery does take place even if the Fed remains at the zero bound.

If scenario #1 occurs and we see a strong economic recovery, banks and credit unions will likely see a surge of loan demand which will require deposits. That will lead to higher CD rates and more CD specials even as the Fed holds rates at zero. A rising stock market also helps this process as investors move their money from cash to stocks.

With at least some possibility of 3% CD specials in 2021, locking into long-term CDs with rates near 1% doesn’t seem like a good strategy. If we do start to see 3% CDs in 2021, it’ll be better to keep cash in online savings accounts or no-penalty CDs. Then you’ll be able to jump on those CD specials when they appear.

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 under 0.50%.

During the zero bound days from 2008 to 2015, online savings account rates remained in a range of 0.70% to 1.00%. Thus, there was little to gain with CDs that didn’t have yields higher than this. I can’t say for sure if online savings account rates will remain in this range this time. As I mentioned above, there are early signs that we may see a lower bottom this time.

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 the possibility of rising rates, choose long-term CDs with early withdrawal penalties of no more than six months of interest.

Another option for your CD ladder is a ladder of short-term CDs, such as those with 1-year terms. Since many 5-year CDs have equal or lower yields than 1-year CDs, the 5-year CD ladders don’t offer much advantage. Of course, 1-year CD ladders don’t offer the rate lock which may be beneficial if rates keep falling.

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 through June. The average rates for CDs with terms over two years are now at 5-year lows. Shorter-term CD rates and savings account rates are still a little above the lows from five years ago. July 2015 was five years ago which was about five months before the first Fed rate hike in December 2015.

Safety of the Banking System and Your Deposits

Even though the banking industry is in a much better position now than it was in 2008, the crisis is stressing the financial system. Weak banks and credit unions will have a higher chance of failing over the next year. Thus, this is the time to be extra careful that your deposits are within the FDIC and NCUA limits.

Post Publication Edits

7/8/2020: Corrected the Northern Bank Direct MM rate in the rate change summary.