Federal Reserve, the Economy and CD Rate Forecast - Nov 19, 2019

Last week’s Congressional testimony by Fed Chair Jerome Powell adds support for the Fed to remain on hold for the foreseeable future. After three straight Fed rate cuts, I think it’s safe to say that Fed rate cuts are over for 2019. That may not be the case for 2020. The Fed’s decision in 2020 will depend on what happens to the economy. If the economy remains on its present path, the Fed is likely to hold steady. If there’s a downturn, another rate cut is likely.

In his Fed Watch blog post, economist Tim Duy summarized Fed Chair Powell’s testimony and what it means for Fed policy:

The Fed remains on hold for the foreseeable future. Powell appeared to lean dovish today, perhaps more so than at the last press conference. That suggests he is very biased against hiking rates until clear evidence emerges that worrisome inflationary pressures are real this time. It also suggests he may have a lower bar to cutting rates than his colleagues.

As Tim Duy describes, the Fed is more likely to cut rates in 2020 than to hike rates. Before deciding to hike rates, the Fed will need to see real inflation threats. There have been no signs of this in the last few years. For the Fed to decide to cut rates, it probably won’t take that much of an economic slowdown.

Another thing to keep in mind is 2020 is an election year. The Fed won’t want to look like it’s making decisions based on politics. That’s another reason for it to hold rates steady. In summary, the bar looks very high for the Fed to return to rate hikes in the next year.

According to the Fed Funds futures (via the CME FedWatch Tool), the odds of the Fed holding rates steady in December are now 100%. There was some uncertainty last week when the odds were 97% of the Fed holding steady. There is much less certainty for 2020. The odds of at least one rate cut by March are 26.8%, up from 23.2% last week. The odds of at least one rate cut by June are 46.1%, down from 50.5% last week.

Treasury yields are mostly down from last week. Recent pessimism on reaching a phase one trade deal with China appears to be the primary reason for this slide. Longer-dated yields had the largest declines. The 10-year yield fell 11 bps, while the 2-year fell 6 bps. This resulted in a narrowing of the 10-2 spread (the difference between the yields of the 10-year and 2-year Treasury notes.) The spread is now 21 bps, down from 26 bps last week. A negative 10-2 spread has a history of preceding recessions.

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

Treasury Yields (Close of 11/18/19):

• 1-month: 1.59% up from 1.56% last week (2.21% a year ago)
• 6-month: 1.58% down from 1.59% last week (2.50% a year ago)
• 1-year: 1.54% down from 1.58% last week (2.68% a year ago)
• 2--year: 1.60% down from 1.66% last week (2.81% a year ago)
• 5--year: 1.63% down from 1.73% last week (2.90% a year ago)
• 10-year: 1.81% down from 1.92% last week (3.08% a year ago)
• 30-year: 2.30% down from 2.39% last week (3.33% a year ago)

Fed funds futures' probabilities of future rate CUTS by:

• Dec 2019 - down by at least 25 bps: 0.0% down from 3.0% last week
• March 2020 - down by at least 25 bps: 26.8% up from 23.2% last week
• June 2020 - down by at least 25 bps: 46.1% down from 50.5% last week

CD Interest Rate Forecasts

CD rate cuts continue to be widespread. With expectations that the Fed will hold rates steady in December and in the foreseeable future, CD rate cuts may soon subside.

Below are a few recent examples of CD rate changes from last week. The first group are changes from the popular banks and credit unions. The second group are changes from the rate leaders or former rate leaders. All of the changes are rate cuts. All percentages are APYs.

• Synchrony Bank (5yr fell 5 bps to 2.25%, 1yr fell 10 bps to 2.00%)
• Sallie Mae Bank (5yr fell 15 bps to 2.20%, 1yr fell 25 bps to 2.10%)
• Capital One (1yr fell 10 bps to 2.10%)
• Goldman Sachs Bank (13m fell 20 bps to 1.65%, 11m fell 20 bps to 1.70%, 7m fell 10 bps to 1.90%)

• Comenity Direct (5yr fell 25 bps to 2.20%, 1yr fell 15 bps to 2.10%)
• M.Y. Safra Bank (5yr fell 10 bps to 2.20%, 1yr fell 10 bps to 2.10%)
• Hanscom FCU (5yr fell 25 bps to 2.50%, 19mo fell 25 bps to 2.00%)
• TotalDirectBank (3yr fell 10 bps to 2.50%, 1yr fell 11 bps to 2.25%)
• First Internet Bank (5yr fell 10 bps to 2.17%, 1yr fell 10 bps to 1.87%)
• WauBank (61m fell 15 bps to 2.35%, 13m fell 10 bps to 2.20%)

As I described above, it appears that the Fed will likely be holding rates steady for an extended pause period. The Fed may eventually return to a slow series of rate hikes, but the odds appear low for 2020. In this scenario, we probably won’t see any widespread CD rate increases until after 2020.

If the economy grows above expectations in 2020, that could put upward pressure on CD rates even if the Fed holds rates steady. We saw the opposite of that early this year. During this time, the Fed held rates steady while concerns grew about the economy. Treasury yields were the first to fall. Brokered CD rates were next to fall. By late Spring, direct CD rates started to fall.

In other scenarios, the economy performs below expectations. That would keep CD rates down for quite some time.

One of these scenarios is an economy that has more of a slowdown than the Fed currently anticipates, but not enough to become a recession. For this scenario, the Fed cuts rates one to three more times, and the extended pause doesn’t begin until sometime in the second half of 2020. The pause would then likely extend through 2021. We would be lucky to see rate hikes in 2022.

The other scenario is the recession scenario. This appears unlikely for now, but it can’t be ruled out. In this scenario, the U.S. economy falls into a recession in the next year, and we return to zero rates. In this scenario, it could take several years before we return to Fed rate hikes.

With rates as low as they are, it wouldn’t take much of a recession for the Fed to return to zero rates. For the period when the Fed held rates near zero (Dec 2008 to Dec 2015), CD rates didn’t fall to zero, but it became difficult to find long-term CDs with rates above 2%.

If it looks like we are headed toward the first scenario, short-term and mid-term CDs would make the most sense. Longer-term CDs make more sense if we’re heading toward more of a slowdown in the economy or a longer pause period.

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.

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 now on the 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.