As expected, no policy changes were announced today at the end of the two-day FOMC meeting. The Fed decided to hold off on a rate hike, but a rate hike in June still looks very likely. The language in the FOMC statement describing the economy supports the continuation of the Fed’s gradual rate hikes. A few small changes in the statement language may be seen as increasing the odds of four rate hikes in 2018 (instead of just three). One is the change in the description of inflation:
The March FOMC statement stated the following on inflation:
On a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent.
This changed to the following in today’s FOMC statement:
On a 12-month basis, both overall inflation and inflation for items other than food and energy have moved close to 2 percent.
All of the voting FOMC members voted in favor of today’s policy action. This shows there are no strong inflation hawks who were willing to go against the majority in favor of a rate hike at this meeting.
June Fed Rate Hike Odds at 100%
The odds of a June Fed rate hike continues to be a sure thing according to the Fed fund futures as shown by the CME Group FedWatch Tool, the odds of a 25-bps rate hike in June is now 95%. The odds of a 50-bps rate hike in June is now 5%. Thus, the odds of at least a 25-bps rate hike in June as shown by the Fed funds futures is 100% which is the same has it has been for the last two weeks.
The odds that the federal funds rate will be at least 75 bps higher in December (four Fed rate hikes in 2018) declined slightly from yesterday, falling from 48.6% to 46.0%. The markets are indicating about a 50-50 chance that the Fed will hike four times in 2018 rather than the three that the Fed’s median expectations suggest.
Future FOMC Meetings
The next three FOMC meetings are scheduled for June 12-13, Jul/Aug 31-1 and September 25-26. The June and September meetings will include the summary of economic projections and a press conference by the Fed Chair.
Deposit Account Rate Predictions and Strategies
An important issue for savers is the decision of how much of their savings should go into long-term CDs vs short-term CDs and savings accounts. Long-term CDs are increasingly becoming less attractive as short-term rates rise more than long-term rates. However, we have seen some upward movement on long-term CDs this year.
Today’s Top Deposit Rates
Below are today’s top rates for nationally-available savings account, 1-year CD and 5-year CD:
- Top Savings Account Rate:
- 2.00% APY, Popular Direct, Exclusive Savings - New Account Rate
- Top 1-Year CD (term equal to or close to one year):
- 2.35% APY, Synchrony Bank, 14-month CD Special, $2k minimum
- Top 5-year CD (term equal to or close to five years):
- 3.10% APY, Northwest FCU, 5-year CD, $100k min, under 62
Note, please refer to this blog post for the ranges of APY available for Northwest Federal Credit Union’s 5-year CD.
Future Top Deposit Rate Predictions
How might these deposit rates change in the next two years? I’m refining my analysis that I did after the January Fed meeting.
Let’s take a look back in history to help predict what we may see. A similar condition existed back in 2006 and 2007 when the Fed was hiking rates. I took a look back at my weekly summary in January 2007, and the top 5-year rate was 6.25% APY at PenFed. The top 1-year CD rate equaled the top savings/money market account rate. AmboyDirect offered the top 1-year CD rate of 5.50% APY, and Superior Savings (which was acquired by Capital One) offered the top savings/MMA rate of 5.50% APY. At this time the federal funds rate was 5.25%.
It’s interesting to note that today’s top saving account rate (2.00% APY) exceeds the top range of the federal funds rate (1.75%) by 25 bps. This is similar to what we saw in 2007. Let’s assume this trend will continue and there will be a savings account with a rate that’s 25 bps above the top range of the federal funds rate.
As you can see in the 2006-2007 rates, top CD rates may not be much higher than the top savings account rates. Long-term rates heavily depend on inflation and economy expectations. Low inflation expectations can lead to a flat yield curve without much difference between short-term and long-term rates. Based on what economists are saying and what we’ve seen in the past, I think a gradual flattening of the yield curve is likely.
Let’s assume we get two more Fed rate hikes in 2018 and three more in 2019. That would result in a federal funds rate in a range of 2.75% to 3.00% near the end of 2019. Let’s assume internet savings account rates exceed the federal funds rate in a pattern similar to both today and back in 2007. Also, let’s assume the top 5-year CD rates will be slightly higher than the top internet savings accounts. I think it could be anywhere from only 0 bps to what we see today (110 bps). For the sake of simplicity, let’s assume a range of 50 to 125 bps. So based on these assumptions, we can make guesses about the top internet savings account rates and top 5-year CD rates at the end of 2018 and 2019:
- Possible Rates by the End of 2018:
- federal funds rate: 2.00% to 2.25% (assumes 3 hikes in 2018)
- top internet savings account rate: 2.25% to 2.50%
- top 5-year CD rate: 3.00% to 3.75%
- Possible Rates by the End of 2019:
- federal funds rate: 2.75% to 3.00% (assumes 3 more hikes in 2019)
- top internet savings account rate: 3.00% to 3.25%
- top 5-year CD rate: 3.75% to 4.50%
Top 1-Year CD vs. Top Savings Accounts
If we do see rates rise as shown above, how would today’s top CDs compare to keeping your money in a top savings account?
I’ll estimate the average earnings in a top savings account by taking the average of today’s top rate (2.00%) with the estimated top rate when the CD matures.
For 1-year CDs, today’s top rate is 2.35% APY (14-month) at Synchrony Bank. The estimated top savings account rate 14 months from now is about 2.75%. The average of 2.00% and 2.75% is 2.38% which is close to Synchrony Bank’s 14-month CD rate.
As you can see, there may not be any advantage with choosing 1-year CDs instead of savings accounts today. Of course, this assumes rates keep rising in the pattern described above. Any shock to the economy that causes the Fed to pause rate hikes would give the advantage to today’s CDs.
Another thing to consider is the level of effort. I’m assuming you’ll keep your money in top savings accounts. Today’s top savings account rarely holds that position for long. You should anticipate that you’ll need to move your money roughly every six months to achieve the average rate estimated above. In the case of Popular Direct, you may not need to move your money, but you may have to still open a new account (see blog post).
If rates should happen to rise more than my estimates above, the advantage would go with savings accounts. Another nice thing about savings accounts is that they make it easy to take advantage of hot CD deals. You can quickly use money from your savings account to fund a hot CD. Of course, deciding if a CD is hot in a rising interest rate environment is difficult. Many readers did not look favorably at PenFed’s 6.25% long-term CDs back in 2007.
5-Year CDs with Small Early Withdrawal Penalties
Another thing to consider is 5-year CDs with small early withdrawal penalties. These are not the deals they used to be. With short-term rates rising faster than long-term rates, the effective yields of 5-year CDs closed early are lower than shorter-term CDs held to maturity. But they’re not so much lower that this strategy should be totally discounted. You can see how Ally Bank’s 5-year CD closed early compares to top shorter-term CDs held to maturity using our CD Early Withdrawal Calculator. I also included a top 5-year CD rate with an EWP of six months' interest (2.85% APY at MainStreet Bank). As usual, beware of banks and credit unions with disclosures that give them the right to not allow an early closure, and beware of the possibility that a bank or a credit union will increase the early withdrawal penalty on existing CDs.