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

It’s widely believed that we’re now in a recession due to the COVID-19 pandemic and the nationwide shutdown that it has caused. The main question for future interest rates is how serious will the recession be. The worse the recession, the longer we’ll be in the ultra-low interest rate environment.

Kiplinger Washington Editors just published their opinion on a best-case realistic forecast. Even this best-case forecast is grim. They forecast a GDP decline of 4% for 2020, which is worse than the Great Recession. It also forecast an unemployment rate that will rise to at least 12%, the highest level since 1940. This best-case forecast assumes that the government’s restrictions on activity begin to abate in May. Then it assumes a strong recovery in the second half of the year.

Of course, how the pandemic evolves will heavily impact the severity and duration of the recession. Also, the fiscal and monetary response will be important. So far the Fed has been able to keep the financial sector running. As economist Tim Duy described in his Bloomberg opinion piece:

To its credit, the Federal Reserve quickly adopted a “whatever it takes” strategy to keep the financial sector intact, thereby already avoiding one disaster that contributed to the Great Depression.

The Fed has gone into uncharted territory with this support. There is always the risk that there will be unexpected surprises for the Fed that crashes the financial sector even with their “whatever it takes” strategy. That would definitely be one of the worst-case scenarios that would result in a prolonged and severe recession.

As I mentioned in previous weeks, even in a best-case scenario in which the economy starts to recover in late 2020, the Fed will likely keep rates near zero as it did from 2008 to 2015. It may not last seven years, but I think it’s likely to last at least two to three years.

The one thing different this time is that the Fed’s “whatever it takes” strategy could have unintended consequences. There is some risk that all the monetary and fiscal stimulus could spark high inflation, and that could force the Fed to hike rates quicker. I still don’t think this is a high probability based on recent history.

Most of the Treasury yields did increase from last week, which, like the recent gains in the stock market, is a sign of rising optimism. The 1-year T-bill had the largest yield gain, rising 6 bps from last week. The long-dated maturities had slight declines. The 10-year yield fell 3 bps to 0.67%, and the 30-year fell 4 bps to 1.27%.

The Fed Funds futures via the CME FedWatch Tool now have little to show. As you might expect, the implied probability of the target federal funds rate remaining at its current 0-0.25% level is 100% for the rest of the year. The futures extend out to March 2021 with the implied probability remaining at 100% that the target holds at 0-0.25%. The futures continue to show zero odds of negative rates.

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

Treasury Yields (Close of 4/6/20):

• 1-month: 0.09% up 5 bps from 0.04% last week (2.42% a year ago)
• 3-month: 0.15% up 3 bps from 0.12% last week (2.44% a year ago)
• 6-month: 0.17% up 5 bps from 0.12% last week (2.46% a year ago)
• 1-year: 0.20% up 6 bps from 0.14% last week (2.43% a year ago)
• 2--year: 0.27% up 4 bps from 0.23% last week (2.35% a year ago)
• 5--year: 0.44% up 5 bps from 0.39% last week (2.31% a year ago)
• 10-year: 0.67% down 3 bps from 0.70% last week (2.50% a year ago)
• 30-year: 1.27% down 4 bps from 1.31% last week (2.91% a year ago)

Fed funds futures' probabilities of future rate changes by:

• April 2020 - no change: 100.0%
• June 2020 - no change: 100.0%
• Dec 2020 - no change: 100.0%
• Mar 2021 - no change: 100.0%

CD Interest Rate Forecasts

There were widespread CD rate cuts as April began, but there weren’t as many cuts as I had feared. Several of the large online banks held steady, and several credit unions didn’t further slash CD rates after slashing rates in March. Nevertheless, we’re seeing fewer 2% CDs. A 2% CD is now rare for online banks, even for 5-year terms. Rates at credit unions are not much higher. There are few more low-2% CDs that remain at credit unions. In another couple of months, 2% CDs may disappear. Hopefully, they won’t become extinct.

As I described last week, not all banks are rushing to slash deposit rates. A pattern that’s similar to what we saw after the 2008 financial crisis is occurring in which some banks see a need to maintain deposits. That has resulted in these banks partially reversing CD rate cuts that were done in March. With the financial support from the Fed, these deposit concerns appear to be easing. Consequently, we’re seeing fewer banks reversing CD rate cuts.

In the following list of CD rate changes from last week, I’ve ordered the list starting with rate hikes, followed by small cuts and ending in either big cuts or low rates. The only significant rate hike I could find was at Banesco USA, which increased its 3-year CD rate by 15 bps to 1.65%. The next three rate changes were at credit unions that only made modest rate cuts to their very competitive rates. The next two rate changes were at online banks that made modest cuts, with new rates still being fairly competitive. The last four rate changes were institutions that either made big cuts or cuts to already low rates. These CD rates are now very disappointing.

Since there were so many rate cuts in the last week, I’m only listing around 10 rate cuts that would be most interesting for DA readers. Also, I’m only including two to three CD rate changes per institution to avoid an overload of data. All percentages listed below are APYs.

• Banesco USA (3yr 1.50% → 1.65%, 1.75% → 1.50%)
• Premier America CU (5yr 2.30% → 2.20%, 1yr 1.70% → 1.60%)
• Hiway FCU (5yr 2.10% → 2.00%, 1yr 1.40% → 1.30%)
• Keesler FCU (30m Jumbo 2.67% → 2.14%, 21m Jumbo 2.13% → 1.87%)
• Merrick Bank (2yr 1.95% → 1.82%, 1yr 1.90% → 1.87%)
• Barclays (5yr 1.85% → 1.70%, 1-yr 1.85% → 1.75%)
• Navy FCU (5yr 1.80% → 1.50%, 1yr 1.65% → 1.55%)
• Sallie Mae Bank (5yr 1.45% → 1.35%, 1yr 1.50% → 1.35%)
• Andrews FCU (7yr 1.40% → 1.35%, 5yr 1.35% → 1.30%)
• Colorado Federal Savings Bank (5yr 1.75% → 1.25%, 18m 1.25% → 0.90%)

I’ll have more discussion of the CD rate changes later today in my CD summary.

For online savings accounts, most banks continue to cut their rates. The last emergency Fed rate cut that lowered the federal funds rate to the zero bound was just over three weeks ago. Most online banks appear to be following a strategy of stretching out the transition to low rates. A few have decided to act quickly with large cuts. Only one bank, Rising Bank, partially reversed its March rate cut.

During the zero bound years from 2008 to 2015, most online savings account rates bottomed out in a range from 0.70% to 1.00%. Thus, additional cuts are likely in the coming months.

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 around 10 rate cuts from the online savings accounts that DA readers would be most interested in. All percentages listed below are APYs.

• FitnessBank Fitness Savings 12.5k+ steps (2.10% → 1.90%)
• Prime Alliance Bank Personal Savings (1.96% → 1.71%)
• TotalDirectBank Money Market Deposit (1.85% → 1.70%)
• American Express High Yield Savings (1.70% → 1.60%)
• WauBank High-Yield Savings (1.70% → 1.60%)
• Western State Bank High Yield Money Market (1.85% → 1.60%)
• Rising Bank High Yield Savings (1.50% → 1.55%)
• Simple Protected Goal Account (1.75% → 1.55%)
• Quontic Bank Personal Money Market (2.00% → 1.50%)
• ableBanking Money Market Savings (1.70% → 1.40%)
• Alliant CU High-Rate Savings (1.60% → 1.35%)

Scenario #1: Pandemic wanes and the economy surges back

It’s possible that the COVID-19 pandemic turns out to be less of a shock to the economy than current expectations. If that occurs, the U.S. avoids a major recession, and the economy surprises on the upside later this year.

As I described above, even if this best-case economic scenario takes place, it seems unlikely rates will rebound quickly. The Fed moved quickly to the zero bound, and it appears prepared to keep it there for several months after the economy recovers. It’s possible that rising inflation could force the Fed to hike rates, but recent history on inflation doesn’t support that. My guess for this best-case scenario is that the Fed goes back to rate hikes in 2023. This had been 2022 last week, but based on forecasts that I’m seeing, 2022 appears overly optimistic now.

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

I’m afraid the odds of this scenario keep rising as the COVID-19 impact to the U.S. economy continues to grow. If we start to see major bankruptcies and panic in the financial markets, the odds of a severe recession increases. If a major recession does occur, the Fed will likely follow a path similar to the one it took after the 2008/2009 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 last 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, but that could change in 2021 even if the Fed remains at the zero bound.

Long-term CDs are making more sense as we appear to be headed back into a long period of very low rates. However, long-term CDs are becoming less attractive as rates fall.

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. Over the last 20 years, each recession appears to bring with it ever lower deposit rates.

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.

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 in March. The longer-term CDs had the largest rate reduction. The average 5-year CD rate is now close to the average rate five years ago before the first Fed rate hike of the last tightening cycle.

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.