I’m happy to report that I have recovered from my sickness that prevented me from publishing the Tuesday summaries last week. Thanks for everyone’s well wishes. It’s very much appreciated.
While I was recovering last week, inflation made news again with the release of the June CPI numbers. It was another month of higher-than-expected inflation. There have now been three straight months of surging inflation, but high inflation is going to have to persist much longer before it impacts the Fed. Last week, Fed Chair Powell testified before Congress on monetary policy. His opening remarks described why they think the high inflation will be temporary:
Inflation has increased notably and will likely remain elevated in coming months before moderating. Inflation is being temporarily boosted by base effects, as the sharp pandemic-related price declines from last spring drop out of the 12-month calculation. In addition, strong demand in sectors where production bottlenecks or other supply constraints have limited production has led to especially rapid price increases for some goods and services, which should partially reverse as the effects of the bottlenecks unwind.
The next Fed meeting is scheduled for July 27-28, and it should be uneventful. No economic projections will be released, and no policy changes are expected. The post-meeting press conference may provide some clues about when taper will begin, but the Fed Chair will likely warn that they are still a long way from meeting their employment goals. According to the June jobs report, there are still 6.8 million fewer jobs than before the pandemic.
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 deposit levels to surge and loan balances to fall. 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. To simplify the review, I’ve decided to look at the current levels and compare them with levels from two months ago.
Fed data released on July 16th showed total deposits of $17.085 trillion and total loans of $10.353 trillion as of July 7th. From May, deposits are up about $20 billion and loans are down almost $13 billion. Deposit growth has slowed compared to the start of the year, but loan growth hasn’t picked up. The best condition for deposit rates is falling deposits and rising loan balances. It's going to take some time for the bank industry's loan-to-deposit ratio to return to more normal levels.
The second factor that may impact deposit rates this year is the economy and Treasury yields.
Treasury yields went up on the 13th when the June CPI numbers were released, but they have fallen since that time. On Monday, the stock market had its worst day of the year due to economic growth concerns from a resurgence of COVID cases. That also impacted Treasury yields. Long-dated Treasury yields had large declines. The 10-year yield fell 12 bps on Monday. From last week, both the 10-year and 30-year yields are down 19 bps. The 10-year yield ended Monday at 1.19%, its lowest level since February 11th. The 30-year yield ended Monday at 1.81%, its lowest level since January 28th.
Most short-dated Treasury yields were either unchanged or had a slight change from last week. The Fed’s new dot plot which suggests that the Fed may hike rates sooner than expected resulted in a small rise in short-term yields after the Fed meeting. Those gains have held, but these yields continue to be near zero.
Odds of Fed Rate Hikes
The odds of a Fed rate hike in 2022 and 2023 fell from last week according to the CME FedWatch tool. This tool lists implied probabilities of future target federal funds rate hikes based on the Fed Funds futures market. The odds of a 2021 rate hike continue to be zero. The odds of one or more rate hikes by December 2022 was 54.5% this morning, down from 72.0% last week.
Treasury Yields (Close of 7/19/2021):
- 1-month: 0.05% same as last week (0.11% a year ago)
- 3-month: 0.05% same as last week (0.11% a year ago)
- 6-month: 0.06% same as last week (0.13% a year ago)
- 1-year: 0.07% down 1 bp from 0.08% last week (0.14% a year ago)
- 2--year: 0.21% down 2 bps from 0.23% last week (0.14% a year ago)
- 5--year: 0.70% down 11 bps from 0.81% last week (0.29% a year ago)
- 10-year: 1.19% down 19 bps from 1.38% last week (0.64% a year ago)
- 30-year: 1.81% down 19 bps from 2.00% last week (1.33% 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 4.2% last week
- Mar 2022 - up by at least 25 bps: 7.0%, down from 14.9% last week
- July 2022 - up by at least 25 bps: 21.4%, down from 36.5% last week
- Dec 2022 - up by at least 25 bps: 54.5%, down from 72.0% last week
- Feb 2023 - up by at least 25 bps: 55.6%
Deposit Rate Changes and Forecasts
Rates have been pretty stable in the last two weeks. The only noteworthy CD rate changes came from a couple of banks and credit unions that have been tweaking their rates.
Abound Credit Union and Quontic Bank are two of the institutions that have been tweaking their CD rates.
Abound recently increased its 47-month CD Special rate 15 bps to 1.45%. It also bumped up the rates of its 6-month, 2-year and 3-year CD rates by 5 to 15 bps.
Quontic Bank did a slight rate bump on its 5-year CD, raising it to 1.11% APY, but it lowered its 6-month, 1-year and 2-year CD rates by 10 to 15 bps.
The stabilizing of CD rates near a bottom can be seen in the Online CD Indexes. Since December, the Online 1-year CD Index and Online 5-year CD Index have been falling very slowly. In May and June, the Online 1-year CD Index had small rate gains. From May 3rd to July 1st, the Online 1-year CD Index rate increased 1.5 bp from 0.436% to 0.451%. The Online 5-year CD Index has essentially held steady for the last three months at 0.65%.
I’m only including one to three CD rate changes per institution to avoid an overload of data. All percentages listed below are APYs.
- Abound CU (47m Spc 1.30% → 1.45%, 2yr 0.75% → 0.85%)
- Quontic Bank (5yr 1.10% → 1.11%, 1yr 0.75% → 0.60%)
- Third Federal Savings & Loan (55m Spc 1.05% → 1.00%)
- AgFed CU (5yr 0.85% → 0.90%, 3yr 0.60% → 0.65%)
- Ponce Bank (4yr 0.65% → 0.50%, 5m 0.40% → 0.25%)
Savings, Checking and Money Market Rates
Liquid account rates have also been pretty stable. However, there were a few more rate cuts.
One of the most disappointing of the rate cuts was at Customers Bank. The Ascent Money Market rate fell 10 bps to 0.50% for balances of $25k+.
Two savings accounts with long histories of remaining competitive had recent small rate cuts. SFGI Direct lowered its savings account rate from 0.56% to 0.51%. This is the first rate cut since January. Vio Bank had a similar rate cut. Its savings account rate fell from 0.57% to 0.53%, and this was also the first rate cut since January.
As these latest rate cuts show, rate declines may not be coming to an end, but they have slowed to a crawl. This can be seen in our Online Savings Account Index which tracks the average rate of 10 well-established online savings accounts continues to change very little. In May, the Online Savings Account Index increased 1.0 bp to 0.456%, and in June, it had a slight decline of 0.5 bp to 0.451%.
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.
- Vio Bank Online Savings (0.57% → 0.53%)
- SFGI Direct Savings (0.56% → 0.51%)
- Customers Bank Ascent Money Market (0.60% → 0.50%)
I’ll have more discussion of the savings and money market rate changes in my liquid 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.
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 couple of 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. 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 80s 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 70s 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. 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 2021 have contributed to the rise of long-term brokered CD rates. This may lead to a rise of long-term direct CDs in 2021 and 2022. However, one 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, Citizens Access 1-year Online CD at only 0.10% and Barclays 5-year online CD at only 0.25%).
Future Rates and CD Term Decisions
It’s possible that we will see a strong economic recovery and/or a steady increase in inflation in the second half of 2021 and that will cause the Fed to signal that it’s thinking about tapering its asset purchases. If that happens, we may see some CD rate gains, especially on 5-year CDs, by the end of 2021 or in the first half of 2022. A strong economic recovery also has other effects that contribute to rising deposit rates. A strong economy results in higher loan demand which requires increased deposits. Also, a rising stock market encourages investors to move money from cash into stocks. That lowers deposit levels at banks.These factors encourage banks and credit unions to raise deposit rates.
In the 2013-2014 Taper Tantrum period, 5-year CD rates at online banks increased 50 to 80 basis points. Larger rate increases occurred at a few credit unions. PenFed had some of the largest increases. Its 5-year rate increased almost 200 basis points. If we see similar rate increases in the next year, we could see top 5-year CD rates at online banks be in a range from 1.50% to close to 2.00%. We could see some CD specials at credit unions with rates above 2.00%.
With at least some possibility of 2% CD specials in late 2021 or 2022, locking into long-term CDs with rates near 1% and below doesn’t seem like a good strategy. The possibility of an inflation surge also doesn’t make long-term CDs appealing. If we do start to see 2%+ CDs in the next two years, it’ll be better to keep cash in online savings accounts or reward checking accounts. Then you’ll be able to jump on those CD specials when they appear. The risk that inflation surges and the Fed is forced to raise rates is another reason to keep your money in liquid accounts.
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 near 0.50%.
During the zero-bound years from 2008 to 2015, online savings account rates remained in a range of 0.70% to 1.00%. There was little to gain with CDs that didn’t have yields higher than this. In today’s new zero rate environment, it appears we are near a bottom for deposit rates. My best guess for this new range for online savings account rates is 0.40% to 0.60%. If you do want to hold CDs, at least make sure that the CD rate is at least higher than 0.60%.
The difficult decision for savers is trying to decide when it’s the right time to lock into long-term CDs. When you see a new higher rate, is it a sign that higher rates are coming which suggests you should wait? Or if you see that a CD rate has reached a certain high (like 2% or 3%), should you acquire that CD? As I mentioned above, it may seem prudent to wait, but as we’ve seen in the past 10 years, rates rarely rise as much as we expect. Once the Fed starts hiking rates, the rate hikes may not last long.
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 July 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 (0.129%) is also at a 5-year low. The previous low was 0.177% in December 2016.