Another Fed meeting is scheduled for next week (June 15-16). No policy changes are expected. For the rest of the Fed meetings this year, there will be a search for signs about when the Fed will begin to taper its asset purchases.
The latest speculation about the taper timing was discussed in this CNBC article. The article includes a possible taper timeline in which the Fed discusses tapering at its June or July meeting, announces tapering at its September or November meeting, and begins tapering in December or January.
If the timeline of Fed tightening follows the last tightening cycle, it may take a long time before we see widespread deposit rate gains. In the last cycle, taper discussions began in May 2013. The Fed announced its plans to taper in December 2013. The first Fed rate hike took place in December 2015. Widespread online savings account rate increases didn’t occur until the second half of 2017.
Of course, the timeline of Fed tightening will depend heavily on how the economy evolves. Based on the recent jobs reports, the Fed won’t find any reason to rush into tightening. The May jobs report was released last Friday, and the job gains were below estimates. However, the report wasn’t as bad as the April jobs report. In the jobs recovery, there is still a long road ahead. As mentioned in this Fox Business article, “the U.S. economy has 7.6 million, or 5%, fewer workers from its February 2020 pre-pandemic level.”
Next week’s Fed meeting will include updates to the Fed’s Summary of Economic Projections (SEP). That will show how the economic numbers have been improving as compared to past Fed forecasts. It will also show the Fed’s expectations about the future target federal funds rate (via the dot plot). In the March SEP, no FOMC participant expected a rate hike in 2021. Only four out of the 18 expected a 25-bp rate hike by the end of 2022. Seven expected at least one rate hike by the end of 2023. Next week, we’ll see if the rate hike camp grows.
The one big difference between the last Fed cycle and the current cycle is that the risk of high inflation appears to be much greater now. Inflation data in the last couple of months has been showing a significant rise in inflation. The May CPI numbers are scheduled to be released on Thursday. We’ll see if the CPI numbers will surprise on the upside again.
Even if inflation continues to be high, the Fed and many economists think that high inflation readings this year will just be temporary.
This opinion about inflation isn’t shared by all economists. Those at Deutsche Bank recently warned of a “potential crisis coming from inflation.” This CNBC piece described their forecasts. According to the Deutsche Bank economists:
“Already, many sources of rising prices are filtering through into the US economy. Even if they are transitory on paper, they may feed into expectations just as they did in the 1970s,”
The Fed claims that it knows how to deal with rising inflation. Its primary tool is hiking interest rates. The Deutsche Bank economists warn that rate hikes could “cause havoc in a debt-heavy world.”
With the Fed’s zero rate policy in a holding pattern for the foreseeable future, two other factors will influence deposit rate changes this year.
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.
As the pandemic ends, consumer spending should rise and the government will hopefully wind down the stimulus checks. That should eventually allow deposit levels and loan balances at banks to return to their pre-pandemic condition, and banks will once again have to worry about attracting deposits.
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, and the data shows that deposits have started to decline. However, loan balances have also declined. In the current state of banking, it will take a long period of declining deposits and rising loan balances before the banking industry’s deposit and loan levels return to normal.
Last week, Fed data released on May 28th showed that deposits in the banking industry increased by only $600 million from May 12th to May 19th. For that same period, loan balances increased $8.80 billion.
For the latest week, there has been a decline in deposit levels. Fed data released on June 4th showed that deposits in the banking industry decreased by $10.6 billion from May 19th to May 26th. For that same period, loan balances declined $2.1 billion.
The second factor that may impact deposit rates this year is the economy and Treasury yields.
The smaller-than-expected May employment gain contributed to a decline in Treasury yields. In the last week, both the 10-year and 30-year yield fell 9 bps. The 5-year yield fell 4 bps.Short-dated yields continue to have no change with yields near zero.
The 10-year Treasury yield closing value today was 1.53%. That’s the lowest close since March 10th. With so many signs of rising inflation, it’s odd that we’re seeing these falling Treasury yields. This piece by Ben Carlson, portfolio manager at Ritholtz Wealth Management, reviewed this condition and offered some possible explanations:
higher inflation and low interest rates can’t coexist forever. Eventually, something has to give.
The bond market doesn’t seem to care about higher inflation just yet. Maybe it will in the future or maybe we’re just going to get an inflationary head fake from the weirdness of the pandemic economy.
Or maybe bond traders know it’s going to be impossible for the government to allow rates to rise substantially in the year ahead.
The slight odds of a 2021 Fed rate hike have gone down a bit according to the CME FedWatch Tool, which lists implied probabilities of future target federal funds rate hikes based on the Fed Funds futures market. The odds of a rate hike by the December Fed meeting went down in the last week from 8.7% to 5.0%. However, based on what the Fed has been saying, these slight odds appear to be too high for 2021. Nevertheless, if inflation keeps surging higher this year, the Fed could be forced to hike rates. The Fed would probably have to see signs of an inflationary spiral in which inflation fears drive inflation higher which then increases those fears. The Fed may feel it necessary to act sooner rather than later in such a scenario.
Treasury Yields (Close of 6/8/2021):
- 1-month: 0.01% same as last week (0.15% a year ago)
- 3-month: 0.02% same as last week (0.17% a year ago)
- 6-month: 0.04% same as last week (0.19% a year ago)
- 1-year: 0.05% up 1 bp from 0.04% last week (0.19% a year ago)
- 2--year: 0.14% down 2 bps from 0.16% last week (0.22% a year ago)
- 5--year: 0.77% down 4 bps from 0.81% last week (0.45% a year ago)
- 10-year: 1.53% down 9 bps from 1.62% last week (0.88% a year ago)
- 30-year: 2.21% down 9 bps from 2.30% last week (1.65% a year ago)
Fed funds futures' probabilities of future rate changes by:
- Jun 2021 - up by at least 25 bps: 5.0%, down from 7.0% last week
- Sep 2021 - up by at least 25 bps: 5.0%, down from 6.8% last week
- Dec 2021 - up by at least 25 bps: 5.0%, down from 8.7% last week
CD Interest Rate Forecasts
There were just four noteworthy CD rate changes in the last week. All were at credit unions. Two of the four credit unions made small rate increases on their 5-year CDs. The other two lowered most of their CD rates.
The few CD rate changes suggest that CD rates have pretty much stabilized near a bottom. There may be a few small rate increases and decreases, but I don’t expect any widespread changes for a while.
The stabilizing of CD rates near a bottom can be seen in the Online CD Indexes. Since December, Online 1-year CD Index and Online 5-year CD Index have been falling very slowly. These indexes track the average rate of 10 well-established online CDs. For May, the Online 1-year CD Index had its first rate increase since January 2020, rising 1 bp from 0.44% to 0.45%.The Online 5-year CD Index didn’t have a rate increase, but the average held steady for the second straight month at 0.65%. The 1-year rate gain was small, but at least it’s a step in the right direction.
I’m only including one to three CD rate changes per institution to avoid an overload of data. All percentages listed below are APYs.
- Blue FCU (5yr 1.05% → 1.10%, 1yr 0.55% → 0.40%)
- Kinecta FCU (5yr Jbo 1.00% → 1.05%, 1yr Jbo 0.50% → 0.55%)
- NuVision FCU (5yr Jbo 1.00% → 0.95%, 1yr 0.60% → 0.55%)
- Pen Air FCU (5yr 0.99% → 0.80%, 3yr 0.80% → 0.70%)
I’ll have more discussion of the CD rate changes in my CD summary later today.
There were just a few noteworthy rate changes of savings and money market accounts in the last week.
The rates at small and new online banks continue to fall toward the averages at the major online banks. BrioDirect and Prime Alliance Bank both had rate cuts that lowered their rates below 0.60%.
Overall, there are signs that rate declines may be coming to an end. Our Online Savings Account Index which tracks the average rate of 10 well-established online savings accounts had its first monthly increase since February 2019. The Online Savings Account Index increased 1 bp from 0.45% on May 3rd to 0.46% on June 1st. Just like the Online 1-year CD Index increase, it’s small, but it’s a step in the right direction.
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.
- Patelco CU MM Select (up to $2k, 2.00% → 1.00%)
- BrioDirect Online Money Market Savings (0.60% → 0.55%)
- Prime Alliance Bank Personal Savings Account (0.60% → 0.50%)
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 March Summary of Economic Projections, no FOMC participant expects a rate hike in 2021. Only four out of the 18 expect a 25-bp rate hike by the end of 2022. Seven 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 in 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 two years, 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 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 May 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 (0.132%) is also at a 5-year low. The previous low was 0.177% in December 2016.